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

Memorandum by Royal Bank of Canada (PRF 46)


  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 bond house.

  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 provincial utilities.

  RBC is neither a shareholder nor a lender to Railtrack.


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 motivated management;

    —  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 structure are:

    —  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.


3.1  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.

3.2  Securitisation

  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.

3.3  Regulation

  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 conditions.


  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.

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