Select Committee on Transport, Local Government and the Regions Appendices to the Minutes of Evidence

Supplementary memorandum by the Department for Transport, Local Government and the Regions (PRF 35D)

  1.  Following the Secretary of State's appearance before the Transport Sub-Committee on 14 November, the Clerk of the Committee wrote to the Department's Parliamentary Clerk on 21 and 23 November seeking answers to a number of questions that Members had not had time to raise and clarification concerning the Secretary of State's evidence in relation to RenewCo. This memorandum provides a response to both letters.

The SRA reviewed each of the passenger rail franchises in the light of the Department's draft directions and guidance and the draft franchising policy statement and made its recommendations to the Secretary of State at the end of August. When will the Department respond to those recommendations and announce what the exact combination of long and short-term franchises will be?

  2.  We expect that the SRA will set out its proposed way forward in relation to existing franchises, for both the immediate and the longer term, in its Strategic Plan. It will in particular show which franchises may be suitable for early replacement or extension. The proposed way forward will of course be subject to change in the light of negotiations with train operators and other bidders for franchises, and of any other relevant change in circumstances.

In view of the flaws in the existing approach to franchise replacement, how can the Department be confident that the new, long-term contracts, where Heads of Terms have been agreed, will be awarded to the operators that submitted the best bids?

  3.  We are satisfied that the SRA has agreed Heads of Terms for the replacement Chiltern, South Central and South West franchises with, in each case, the operator which offered the best bid. In each case the bidding process was competitive and the criteria for selection reflected the requirements of affordability and value for money; and each of the successful bids will offer early benefits to passengers. The proposed changes in the approach to franchise replacement will not affect the criteria on which a successful bid is selected, though it is hoped that they will make the process more manageable for bidders and the SRA, and will provide additional clarity to bidders about the benefits, which the SRA is seeking to secure.

Even with the provisions made under section 54 of the Railways Act 1993, Great North Eastern Railway says that it will be unable to introduce new rolling stock with only a two-year franchise extension. What action is being taken to address this problem?

  4.  The aim of extending GNER's existing franchise for two years would be to secure early additional benefits for passengers, including in relation to rolling stock. The terms of any extension are, however, a matter for commercial negotiation between the SRA and GNER.

How will the doubts that remain about the ability of Railtrack's successor to secure a BBB credit rating be addressed?

  5.  It is for the Administrator to put a proposal for a transfer scheme before the Secretary of State based on propositions he, the Administrator, has received and evaluated. The guidelines published by the Secretary of State on 31 October specify that any bidder should be able to demonstrate that their proposal for a successor to Railtrack plc will have a sufficiently high, investment grade, credit rating to raise the necessary finance for its activities.

  6.  As far as the proposal for a Company Limited by Guarantee is concerned, it is intended that this would, if accepted, result in the transfer of the business of Railtrack plc and its finance creditors' indebtedness to a new, financially sound, vehicle. We anticipate that in practice lenders would view the company as a very low credit risk and a sound basis for their investment.

  7.  A CLG could operate with much lower risks than Railtrack, concentrating on operating and maintaining the infrastructure as well as undertaking small-scale renewals. It could receive income from track access charges, property and grant, of which some 90 per cent could be covered by stable long-term contracts. In addition a "cushion" between the risk of poor financial performance and debt providers could be provided by using retained surpluses to build up a reserve and an arrangement by which the company could, in specified circumstances access a standby, subordinated loan facility up to a capped amount.

  8.  We have also reaffirmed our intention that our proposal would, taken in the round, preserve the economic rights of the current finance creditors in all material aspects. Such proposals must, however, retain the flexibility to translate some of the detailed terms and conditions of the debt into a form that reflects the different structure and credit rating of a company limited by guarantee.

How has the Government satisfied itself that a BBB credit rating will be adequate to raise the private sector capital that will be needed by Railtrack's successor?

  9.  In relation to the proposal for a Company Limited by Guarantee, it will be targeting a long term credit rating of A/A2 or higher, to reflect the financing capacity requirement of the rail infrastructure business. This would secure a robust balance sheet for the company and enable it to raise debt financing in an efficient and cost-effective manner.

How will the regulatory structure of the railway industry be revised in order to "reduce the burdens of day-to-day interference" in the industry?

  10.  The principal objectives of reform of the regulatory structure will include a reduction in the overlap of interests between the SRA and the ORR, and a closer alignment of the interests of Railtrack's successor and the train operating companies. This will reduce the amount of conflict and confrontation, and the need for regulatory interference.

How will the "self-defeating system of penalties and compensation" imposed by the existing regulatory structure be changed?

  11.  The review of the regulatory structure offers an opportunity to reform and rationalise the current SRA and ORR incentive and performance regimes, allowing incentives to be set in a clear and integrated manner, providing better alignment of incentives across the industry.

What is the role of independent regulation given that the independence could be removed by legislation if the regulator proposed to act in a way which was contrary to Government policy? How much assurance will "independence'"give to the financial markets?

  12.  It is important that regulatory decisions properly reflect public interest considerations and resource constraints within the industry. In addition, there needs to be some form of independent regulation to ensure that the monopolistic power of the infrastructure manager is not abused, that the price of access to the network is determined in a fair manner, and to arbitrate in the event of disputes. An independent regulatory check will assure investors that the revenues available to the infrastructure provider will be established on a fair basis.

Reference was made during the meeting to Sir Alastair Morton's concern at "the Rail Regulator's hand getting into the SRA's pocket to remove money" in connection with the former's periodic review of Railtrack's access charges (see Q828 in the transcript). Should it not be for the SRA to determine how the overall amount of Government support for rail is used?

  13.  The Government has a budget for rail and the ORR must take the capacity of the SRA to pay into account when carrying out its periodic review. Our commitment to streamline regulation will look at how these issues play out in practice. The retention of an element of independent economic regulation is necessary to ensure that the price of rail outputs and access are determined on a fair basis, and to provide an appeal body for disputes.

Has the placing of Railtrack Plc (into administration) not diminished the prospect of the private sector investing in the railways as anticipated in the 10 year plan?

  14.  The Government remains confident that private sector investment will continue to flow into the railways to enable us to deliver our 10 Year Plan targets. In a number of respects the successor company to Railtrack could actually improve the prospect of private sector investment. For example, it could provide greater management efficiencies; and an asset register to improve the underlying knowledge of the state of the assets and their costs. The successor company could provide co-operation with SPVs in the planning of investments and their integration into the network on completion.

What proposals are there for increasing the size and changing the timing of the funds that will be made available to the SRA for rail investment, as has been advocated by Sir Alastair Morton?

  15.  The Government has committed to provide over £30 billion of public support to the rail industry over the next 10 years. It expects the SRA Strategic Plan to prioritise the rail investment projects required to deliver our 10 Year Plan rail targets and the allocation of the resources required. Of course, neither the 10 Year Plan nor the SRA Strategic Plan are static documents and they will be reviewed at certain points to assess and respond to progress made against the key objectives and targets.

In its memorandum, the Department referred to the target for increasing rail freight over the life of the 10 Year Plan as being by "up to 80 per cent" (para 25), as did the Secretary of Sate in his oral evidence (see Q822). Transport 2010: the 10 Year Plan, however, refers to "an 80 per cent" increase in rail freight (page 100). Does this change represent any weakening in the Government's commitment to increase freight traffic on the railways?

  16.  The relevant section of the 10 Year Plan, on page 100 is headed "Summary of other 10 Year Plan targets and indicators" and reads, in full:

  "a significant increase in rail freight's share of the freight market by 2010. We believe it ought to be possible to increase market share to 10 per cent. in 2010 from 7 per cent now—an 80 per cent increase in rail freight—provided the rail freight companies can deliver improvements in performance and efficiency".

  17.  The proviso is important. The statements by the Secretary of State and in the Department's memorandum are accordingly qualified, and consistent with the 10 Year Plan.

Several references (eg Q855) were made during the Session to the RenewCo Proposals. Who took the decision not to proceed with the RenewCo Arrangements and when was it taken? What was the Department's precise role in the decision making process with regard to the RenewCo proposals? What was the Department's role in mediating between the parties to the RenewCo proposals? Who took the decision that the conditions for the RenewCo proposals had not been met?

  18.  In October 2000 the Rail Regulator made his determination of Railtrack's revenues for the second control period (CP2), from April 2001 to March 2006. Under this determination the first £162 million instalment of capital grant was due to be paid on 1 October 2001.

  19.  In April 2001 Railtrack and the SRA, with the Government's agreement, undertook to use their best endeavours to put in place the RenewCo scheme, whereby the capital grants due to Railtrack under the October 2000 determination would be paid instead into a new special purpose vehicle. It was agreed that RenewCo would not go ahead if it was to be consolidated in either Railtrack's accounts or classified as being in the public sector.

  20.  By the end of September Railtrack and the SRA had not received confirmation from the independent Office of National Statistics on the classification of RenewCo. As a result the payment of £162 million into RenewCo on 1 October could not be made. However, Railtrack could have received £162 million on 1 October under the October 2000 determination. This sum of £162 million was available on 1 October for Railtrack and was, therefore, not blocked. In fact, Railtrack made no request for the money to be paid under the October 2000 determination.

  21.  On 5 October the Office of National Statistics determined that RenewCo would be classified in the public sector. This meant that the conditions for proceeding had not been met.

  22.  The Committee needs to draw a clear distinction between the RenewCo scheme which was the subject of Sir Alastair's letter and the payment of £162 million which could be made available either under the October 2000 determination or by payment into RenewCo had the conditions agreed to in April 2001 been met—which as a result of the ONS classification they were not.

Dates of meetings the Secretary of State has had with Sir Alastair Morton, the Chairman of the Strategic Rail Authority (see Q860)

  23.  The Secretary of State had meetings with Sir Alastair on 26 June and 24 July this year. He was also present at the Rail Delivery Group, which the Secretary of State chaired on 27 July.

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