Memorandum by Susan Kramer, Liberal Democrat
Candidate for Mayor of London (FLU 02)
1. INTRODUCTION
1.1 London's first directly elected Mayor
will have a unique opportunity to shape the destiny of London's
transport system, and with it the quality of life for millions
of Londoners.
1.2 The election on 4 May is in part a referendum
on how that Mayor will use that opportunity and what specific
ideas and programmes he or she has to finance and make the system
work for Londoners.
1.3 If elected on 4 May, I will work in
partnership with many stakeholders in London's transport system
to keep London Underground in public ownership. I believe that
financing for the deferred maintenance investments and the capital
investments needed to bring Tube infrastructure up to standard
should be raised through revenue bonds backed by fares and congestion
charging in central London.
1.4 My most immediate priority will be to
deliver the money and the management to reverse decades of neglect
and under-funding of London Underground. My approach draws on
my experience as an international banker.
1.5 Provided the Government does not seek
to stand in the way, I will launch the necessary management reforms
and the first revenue bonds for Transport for London (TfL) within
six months of taking office. Most of the required legislative
authority is already in place. While it will take time to fully
overcome years of neglect, my first term will halt the continuing
decline in services and will lay the institutional and financial
foundations for the long-overdue re-building and modernisation
of London's transport systems for the 21st century.
1.6 This Committee's and the National Audit
Office's commitment to ongoing oversight and scrutiny of the Government's
ill considered Public-Private-Partnership (PPP) scheme will be
crucial over the next several months. In particular, I would urge
this Committee to evaluate the PPP (and any contracts which the
Government may propose to award prior to the Mayor taking office)
against my proposed alternative.
2. PROBLEMS WITH
THE PPP
2.1 The Treasury openly admits that the
cost of funds under the PPP are much higher than the cost of funds
under a revenue bond scheme (published reports put the PPP interest
rate at 12 to 15 per cent vs around 5 to 6 per cent for my proposed
revenue bond structure). This works out to more than one billion
in extra financing costs that could be better invested in the
tube itself. The Treasury argues, however, that the much more
expensive PPP financing works out to be cheaper due to management
efficiencies.
2.2 There is very little basis for accepting
the Treasury's view. In fact, it is possible to combine the cheaper
financing of revenue bonds while still attaining greater management
efficiencies. Under my Plan, individual contracts would be bid
out to the private sector using state-of-the-art programme management
and maximum price, turn-key contracts. These contracts can, and
should, be structured to provide for much greater competition
at the bid stage, resulting in lower prices. These contracts will
also allocate cost-overrun and delay risk to construction companies
and suppliers, in a much more targeted and effective way than
under the PPP.
Under the PPP, the long-term, contracts would
be awarded to large, unwieldy consortia, with no ability for Transport
for London to pick and choose among the various consortium members
to get the best equipment supplier, civil contractor, track maintenance
company, etc. Once the contracts are awarded any competitive pressures
to keep prices down and improve quality and accountability will
be greatly diminished. The universe of potential bidders is also
much smaller. Since competitive pressures disappear from the day
the PPP contracts are signed, London Underground will be in a
weak position to negotiate the periodic reviews and removal of
the franchise will only be possible in the most egregious circumstances,
involving expensive and lengthy litigation.
2.3 The second major problem with the PPP
proposal is the essential break up of the tube network. The PPP
plan separates the tube in to four pieces. Three companies will
own the infrastructure, with London Underground remaining as the
operating company. As has been widely publicised with the break
up of the rail network, this can lead to serious problems and
severe loss of accountability when things go wrong. Another consequence
of breaking the tube in to different pieces is that each piece
will have different interests. The infrastructure companies do
the best for their shareholders by putting as little money in
to the tube as possible. There is also the difficulty of co-ordinating
the different consortia. For example, if one of the infrastructure
consortia is experiencing delays, how are the other consortia
compensated for the impact on their timetable etc.
2.4 Because of the transfer of most of London
Underground's engineering "know-how" and infrastructure
experts to the private companies under the PPP, London Underground's
ability to manage them or take back responsibility is diminished
year-by-year. Indeed, it will be difficult for any outsider to
put in a successful competing bid after the franchises end which
is why these are, in effect, infinite life concessions.
2.5 On some occasions a glib argument is
made that under a PPP risks are transferred to the private sector
which cannot be transferred by retaining public ownership. This
is a serious misunderstanding of risk allocation. Private companies
will take only those risks which are appropriate and which they
can expect to control and will do so under the PPP or any other
scheme. No sensible private company will accept a risk without
receiving full payment for it and to do otherwise would be to
fail its shareholders. This risk premium rarely appears as a stated
item in submitted bids but is reflected in higher than otherwise
construction or maintenance costs.
2.6 Finally, the PPP proposal locks in for
25 years the development plan for the tube. This constrains flexibility
as transport needs change (eg few predicted the upsurge in demand
we are now experiencing; any PPP done five years ago would now
be going through very expensive overhaul to meet changes—essentially
TfL would have to buy out the infrastructure companies to get
change).
3. ADVANTAGES
OF MY
PLAN
3.1 My plan combines cost effective financing
with management improvements and clear accountability. The tube
remains in the hands of a London Underground which will be accountable
to Londoners and as a single integrated entity. (The effect of
the PPP is a virtual transfer of ownership of the tube infrastructure
to private companies.) This means that responsibility and accountability
for the safety of the tube and improvement of the tube remains
with the public sector and is not lost to private companies.
3.2 My Plan is much cheaper. Whatever financing
strategy is used to fund investments in the tube, the primary
source of payment towards that financing will be the fares paid
by users who travel by tube. Finding the lowest cost source of
financing is the best mechanism possible to insure that fares
are kept down. As discussed above, all sides, including the Treasury,
accept that revenue bonds are a much cheaper source of financing
than the PPP proposal. Also, as discussed above, private sector
efficiencies are still brought into my Plan, eliminating the notion
that the PPP would somehow overcome it's much higher interest
rate by providing more efficiency.
4. NEW YORK
CITY EXAMPLE
4.1 My plan builds upon the success of other
big city transit systems, which have faced and dealt with similar
funding and management issues as London Underground. The public
transport system in New York City is an instructive guide in to
how my Plan would work.
4.2 As in New York, the cornerstone of my
funding plan will be the issuance in long-dated Transport for
London (TfL) Revenue Bonds, similar to the $13 billion in outstanding
New York Metropolitan Transit Authority (MTA) revenue bonds.
4.3 As in New York, I propose to keep the
tube in public hands, reform its management and take advantage
of private sector management skills. Coupled with efficient, well-designed
contract procurement, my Plan will deliver the tube's long-deferred
capital maintenance and other improvements efficiently, on schedule
and on budget.
4.4 As in New York, the bonds would be secured
by a gross revenue pledge of fare and other system revenues. I
would also add central area congestion charges which I will introduce
during my first term as Mayor. As in New York, the bonds would
not be guaranteed by the Government or London. The disciplines
of the financial markets and the rating agencies will be brought
to bear on improving management and controlling costs.
4.5 Depending upon the final structure of
the proposed TfL bond issue(s), we believe they should be able
to achieve a stand-alone investment grade rating, at or above
the MTA's BBB+ rating.
4.6 The principal difference between the
NY MTA and proposed TfL issues is that London Underground generates
nearly £500 million in operating surpluses as opposed to
New York, where farebox and other system revenues only cover approximately
56 per cent of the MTA's subway and bus and 66 per cent of its
commuter rail operating costs. New York also has lower fares and
benefits from higher levels of Federal and State operating support
as well as certain other earmarked taxes and fees (including the
revenues from the toll revenues from the bridges and tunnels coming
into Manhattan). The role played in New York by those additional
revenues in keeping down fares is comparable, though greater in
degree, to London's proposed congestion charge.
4.7 The other key difference is that the
MTA bonds are tax exempt and part of the $100 billion plus per
year, new issue US domestic revenue bond market where there is
long-standing investor appetite and understanding for high credit
quality, 20 to 35 year paper of this type. Given the UK budget
surpluses, bond redemptions and shrinking UK gilt and other public
issues (particularly at the long-end of the market), there would
be strong UK and international investor interest in long-dated,
high credit quality Sterling (and eventually Euro) denominated
bonds for the Underground.
4.8 Our preliminary market sounding have
indicated that these bonds could be sold at a rate of approximately
1 to 1.25 per cent over 25 year Gilts, which works out to approximately
5 to 6 per cent.
5. CONCLUSIONS
5.1 Given that the same or better management
efficiencies and risk transfers can be obtained under my Plan
as under the PPP, I can see no economic reason for going for the
PPP except ideology or outdated RSBR rules.
5.2 Let us combine the lowest cost financing,
the accountability of an integrated system and the best management
by introducing the reforms that I have described while keeping
ownership in public hands.
March 2000
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