Shaw report rejects full bloodied privatisation but welcomes private capital

The long expected Shaw report –The future shape and financing of Network Rail – has finally been released and partially allays fears about large scale privatisation; but it argues that alternative sources of finance need to be found. Shaw also calls for greater rail devolution and for a new Northern route to serve the north of England.

“The report team is not recommending the introduction of private sector capital at the whole company level, recognising that, for the foreseeable future, Network Rail ownership will remain in the public sector,” Shaw reassures.

Shaw lists seven main recommendations and admits that there are ‘no silver bullets’ or easy solutions to the problems facing the industry. The pre-report consultation drew in over 10,000 responses and the three main concerns expressed were:  opposition to any break up of Network Rail; opposition to its privatisation; and fears that the current high levels of investment will not be sustained.

Nicola Shaw’s report team worked closely with Network Rail, the ORR, the DfT and HM Treasury (HMT).

Network Rail was set up in 2001 in the wake of the Hatfield and Potters Bar rail crashes but Shaw says the current structure is no longer appropriate. The maintenance backlog problems endemic then have since been addressed. It is time to move on: “Since the early 2000s, the world has changed at a rapid pace, and the heavily centralised and ‘top-down’ planning model of the early Network Rail is no longer appropriate.”

NR suffers from poor financial discipline, an all too evident fact following its September 2015 re-classification as a public sector body.

“Prior to reclassification, Network Rail was considered a private sector company and raised finance from debt markets against its regulated asset base (RAB). In simple terms, this effectively meant that it used the value of its assets (for example tracks and signals) to borrow money.

“Because debt was cheap, in part thanks to the government’s guarantee of Network Rail’s debt, the company had little incentive to improve its financial discipline. If it overspent on capital it was simple, with the agreement of the Regulator, to add most of any overspend to the RAB – colloquially known in the industry as the ‘credit card’ – and government paid the additional costs over time. But like adding to any debt, this was unsustainable in the longer term – something brought into sharp relief after the reclassification of the company to the public sector and the introduction of a borrowing limit for Network Rail.”

Poor financial management has resulted in a significant overspend in major enhancement projects, notably  the Great Western Electrification Programme (GWEP), and even on core functions (such as operations, maintenance and renewals) which were £200m more than planned in 2014/15.

The ongoing £15bn enhancement programme agreed under CP5 (2014-19) only underlines the scale of the problem and how much is at stake.

Devolution

Shaw wants more power devolving to NR’s routes (or regional areas). Currently they number eight:  Anglia; LNE (London North East); LNW (London North West); South East; Wessex; Western; and one each for Scotland & Wales. (Since 2013 these routes have been sub divided into smaller areas).

“Decentralisation and route autonomy should be pushed further: routes should be empowered to operate as independent divisions within the overall business and assessed individually against their ability to meet customer needs and expectations.”

Each route would have its own CEO and management board to achieve financial and operational independence: “The route management boards should be able to have delegated authority for the majority of the company’s activities for their route and assume responsibility and accountability for the route’s finances and operations. Network Rail should also consider having route management boards independently chaired.”

But Network Rail would remain one company.

There would also be a ‘virtual freight route’ to give a single point of contact for freight users and the freight route CEO would enjoy equal status with the route CEOs.

The biggest change would see the creation of a new Northern route carved out of the existing LNE North, LNW North and LNE Central areas: “The report team estimate that the transition costs associated with this could be in the single figure millions.”

A Northern route would fit in with the creation of Rail North and the re-awarding of the new Northern and Trans Pennine Express franchises which start on 1 April.

Northern route
New Northern route would be carved out three existing ones

While the Western, Anglia and South East routes broadly align with their English regional counterparts (South West, East of England & South East respectively), the same cannot be said of the other routes. However no further route changes are being contemplated; a new route for London – currently served by six routes – is dismissed as ‘not currently a deliverable proposition’.

Devolution would facilitate benchmarking enabling comparisons to be drawn between different routes. Shaw says the ORR should learn from other regulated industries, notably energy, airports and water.

“The report team recommends that the ORR should, for the next periodic review, regulate Network Rail on a route level, setting regulated outputs, expenditure and revenue by route. . . In order for the ORR to be able to set, monitor, and enforce separate regulatory settlements for routes effectively, it will be important for each route to produce and to publish full, separate regulatory accounts.

“To maximise the benefits of this approach, it will be important for there to be a clear ring fence around these route accounts . . . In order to be effective, the routes will have to receive the track access charges and single till income that they generate. Currently, track access charges are paid to Network Rail.”

Shaw stresses: “The timing and pacing of this report’s recommendations will be essential to their effective delivery. If these recommendations are to be a success, work on implementation should start immediately, and involve all players. The key structural recommendations – specifically the new route for the North, further devolution of powers to routes with separate regulatory settlements and financial accounts – need to be in place for the beginning of CP6 in 2019 to avoid protracted and unnecessary uncertainty and to deliver the benefits for the travelling public as soon as possible.”

Private finance

While Shaw is not calling for full-bloodied privatisation or the break up of Network Rail, she is mindful of the government’s drive to reduce the budget deficit and cut public expenditure. NR can no longer rely on the state to bankroll its enhancement programme in full so there will be increasing scope for private sector third party investment in the future.

Though not coming within the scope of the report, NR – following on from the Hendy Review – has begun the process of disposing of ‘non-core assets’ (depots, stations and adjacent land) to raise £1.8bn. This is a start towards plugging the funding gap but that alone is unlikely to suffice.

Shaw looks at various ways of attracting private capital into Network Rail; a hybrid concession model (someway between traditional regulated asset ownership and a conventional concession) is envisaged:

“The proposed model provides for: (1) the award, through a competitive tender to a private partner, of exclusive rights to operate, maintain, renew and in some cases invest in the further enhancement of the assets for a fixed period of time (typically 20-30 years), protecting national ownership of the railway; (2) an upfront sum paid by the concessionaire (or licensee) to the Secretary of State for Transport in return for an income stream deriving from the asset; (3) regulation, with price control periods and a regulatory asset base (RAB), to provide flexibility on investment requirements, spreading the capital expenditure over the life of the assets, while also mitigating the risks associated with potentially imperfect asset knowledge and providing the appropriate benchmarks for efficiency; and (4) clear risk transfer (from the public to the private sector – Ed),” Shaw explains.

Such a concession or time-limited licence would have to undergo a stringent five-point public interest test beforehand:

“The public interest assessment would need to take into account the following aspects: (1) delivery, i.e. the need to deliver customers’ and funders’ objectives over the 20-30 year life of the contract; (2) flexibility for the future, i.e. the need to be able to respond effectively to the dynamic environment of the railway – as passenger and freight requirements may change over the life of the contract – without substantial renegotiation with lenders as well as government; (3) off-balance sheet treatment, i.e. that the structure is accounted for off the public sector balance sheet by the ONS; (4) affordability; and (5) value for money.

“If these tests were passed in the round then it would be appropriate for the government to proceed.”

Any would be concessionaire would have to be a genuine stand-alone private sector company with a balance sheet outside the public sector:

“It will be for the Office for National Statistics (ONS) to judge whether or not the transferred asset (and its associated debt and spending) remains on the government’s balance sheet. However, the report team is confident that the model proposed above could achieve off balance sheet treatment. To achieve this, the concessionaire (or licensee) would have to, in the judgement of the ONS: (1) be a private sector institution; (2) bear the majority of risk and reward associated with the asset, rather than the government; and (3) not, through contract or otherwise, be deemed to be controlled by government or by Network Rail.”

In the event of a failure (to enact enhancements) there would be a provision to buy back a concession at a ‘fair price’. Routes would not be able to hold debt independently, but debt could be apportioned to individual routes (as it is already done in Scotland).

Private sector involvement to date has produced mixed results: Shaw says lessons have been learned from the three unsuccessful PPPs (public-private partnerships) introduced by London Underground in 2003. The attempt to separate train operations from train and infrastructure maintenance proved excessively complex and was a costly failure resulting in TfL wresting back control between 2007 and 2010.

On the other hand, the concession model has already been used to good effect in the UK; the HS1 concession runs from 2009 and 2040 – Shaw co-incidentally having previously served as HS1 CEO.

“Wessex and Anglia are currently the strongest candidates for a concession or a time-limited licence because they have no or low levels of public subsidy and little forecast enhancement activity,” argues Shaw.

With a 20-30 year old concession or licence proceeds to the state could be used to repay the legacy debt or fund expenditure elsewhere on the network.

Parts of routes could be considered for concession arrangements as well; the Welsh Valleys lines and the Essex Thameside franchise are cited as possible candidates.

Shaw suggests other ways of drawing in private sector capital; signalling manufacturers and/or rolling stock companies could fund signalling improvements to increase capacity and replace costly equipment.

Shaw gives other examples:

(1) Support from local developers who will benefit from the additional transport options provided upon completion of specific enhancements – these would be true private sector funding contributions (similar in fashion to those made for the Canary Wharf Crossrail station);

(2)  The design-build-finance-transfer (DBFT) model that was used in the procurement of one of the Chiltern Evergreen’s projects – this would be private sector money to finance the delivery of the project;

(3) Models akin to TfL’s new procurement approaches, including the Innovative Contractor Engagement (ICE) applied for the Bank station improvement works, which would represent an evolution of Network Rail’s alliancing procurement process to seek more innovation and clarification of what is required to reduce uncertainty. ICE can draw on private investment as part of a wider package of measures to progress enhancements; and

(4) A combination of all of the above, which, coupled with alternative public sector funding sources discussed later in this section (e.g. community and business levies) would allow private sector contribution to support the viability of a project.

Finally, public sector funding forms another potential capital source: the GLA business rate supplement is contributing £4.1bn towards the £14.8bn Crossrail project, and local authorities have imposed levies on developers to contribute towards the cost of the Northern Line (Battersea) extension and the Scottish Borders projects.

Other Points

 A common theme emerging from the consultation feedback was a sense of ‘disempowerment’: “Customers, passengers and freight shippers expressed frustration that decisions are taken in their absence, in a way that makes them feel that the railway operates in spite of them rather than for them.”

Shaw lists four major concerns about the enhancement programme: (1) a lack of local control over planning and decision making; (2) a lack of customer and end user focus in planning and delivery; (3) a lack of transparency around how planning decisions are made; and (4) a short-term approach to planning and funding.

Current infrastructure planning is based on five year periods but there is no long term strategic planning for the industry as a whole. A 30 year vision is required, and:

“The report team also advocates re-aligning rail investment decisions with standard public sector timetables, and moving away from fixed five year spending periods which are often unsuitable for rail enhancement projects. Meeting these aims will mean fully separating enhancements planning from the settlement process for operations, maintenance and renewals (OMR).”

Shaw also maintains that the government’s role should be better defined: “We recommend that government involvement in the railway in England and Wales should be updated to separate its distinct roles of owner, funder, and client for enhancements, and operations, maintenance and renewals.”

The Shaw Report: the future shape and funding of Network Rail

https://www.gov.uk/government/publications/shaw-report-final-report-and-recommendations

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