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

Memorandum by Transport for London (LU 03)



  London Underground Limited (LUL) is a vital public asset both for the capital and the country. It is the single most important part of London's public transport infrastructure, carrying over three million passengers on a typical weekday. The Underground now carries approximately the same number of passengers as the entire National Rail network in the United Kingdom (UK) and generates over £1 billion in revenue income annually.

  Nearly three years and seven months ago, on 20 March 1998, the Deputy Prime Minister announced to Parliament plans for a Public Private Partnership (PPP) to modernise the Underground[8]. He described the Government's solution as representing "an entirely new approach—a third way. It is not privatisation—or even partial privatisation; nor is it an old-style, publicly funded nationalisation. It is a publicly owned, publicly accountable model to get the best from both the public and private sector".

  This paper sets out Transport for London's (TfL) objections to the PPP and our alternative plan. We have consistently maintained that the wholesale ceding of management control over both Underground investment and day to day maintenance to private interests is a risky experiment that is unsafe, unmanageable and unnecessarily expensive. Recent experience with Railtrack supports this point.

  Regrettably, the complexity and incoherence of the PPP has only increased as the process has developed. More than ever the PPP is a dangerously bad idea.

  An effective programme to modernise (and expand) the Underground must be, in TfL's opinion, a strategic UK transport priority, not least because of London's economic importance to the country as a whole. We call on the Government immediately to transfer the Underground to TfL, who have an alternative management plan ready to implement.


  The Government should not sign the PPP contracts because:—

    —  PPP is unsafe and unmanageable.

    —  PPP does not deliver value for money.

    —  The proposed contract terms do not properly protect the public interest.


  Safety on the Underground under the PPP will rely on the ability of LUL to adhere to its HSE approved Safety Case when most relevant safety activities have been contracted out to the Infracos who must in turn comply with LUL's Safety and Engineering Standards. As we know from the Railtrack experience, safety is by no means guaranteed by contract assurances.

  A major criticism of the failed Railtrack experiment was that safety was compromised by the fragmentation of the system whereby train operations and right of way maintenance were separated. This fundamental obfuscation of accountability was compounded in most observer's views by Railtrack's further sub-contracting of safety critical track maintenance to Balfour Beatty (who are part of the Metronet consortium which is preferred bidder for two of the three PPP contracts). Put simply, this is essentially the model now proposed for the Underground. The right hand of Government is correcting this elementary mistake while its left hand is repeating it.

  Under the PPP LUL will retain the statutory responsibility to ensure safety. However, as in Railtrack, while LUL will operate trains, it will lose control of the condition of the infrastructure, including rolling stock, track, signals and tunnels, all of which will be maintained by the Infracos. In order to meet its safety obligations without control of those key pieces of infrastructure, LUL must rely on the terms of its PPP contracts with the Infracos (which require them to have and comply with a contractual safety case and LUL's Engineering Standards) and keep its fingers crossed that the Infracos and any party to whom safety sensitive work is subcontracted by the Infracos, will provide it in good time with sufficient information to enable it to assess whether all safety critical activities have been performed, whether the relevant Infraco has complied with its safety case, and if not, whether the complex contract provides any realistic remedy for the Infraco's failing.

  As we have seen with Railtrack, this is a fragmented system which clouds accountability and encourages "buck passing" and in which the commercial disincentive to provide safety critical information to the party with the statutory responsibility for safety is strong. The PPP contractors will be penalised if they fail to improve capability, reliability and ambience, and will receive bonuses for improvement. In fact their financial models require that they receive significant incentive payments to achieve the profitability promised to investors. As Lord Cullen observed in the Railtrack context "the magnitude of the penalties that are likely to be imposed for poor performance and the gross disparity which exists between performance and safety sanctions respectively, may well have conveyed to the industry the message that performance was the top priority". While there are differences between the Underground PPP and the Railtrack structure, the PPP incentive structure provides the same message and will lead to the same priorities.

  Neither can the public take comfort in LUL's Engineering Standards to control Infraco behaviour. Parsons Brinckerhoff, a leading international transport engineering firm, reviewed LUL's Standards on behalf of TfL and concluded that they "are inappropriate and inadequate to serve as an effective management control mechanism to protect the public interest in performance based PPP contracts with privately owned Infracos".


  Evaluation of London Transport's (LT) Value for Money (VfM) analysis of the preferred bids in both the deep Tube and sub-surface competitions demonstrates that the cost savings originally promised to Parliament when it endorsed the PPP have proven illusory. This is because:—

    —  An analysis prepared by LUL's financial advisors, PricewaterhouseCoopers (PwC), submitted to Parliament in 1999 promised savings of £4.5 billion over the first 15 years of the PPP. A review by Deloitte and Touche of the Public Sector Comparator (PSC) and preferred bids finds that the Government's plans do not demonstrate value for money. The savings are nowhere to be found.

    —  When Parliament examined the PPP it did so on the basis of the PwC figures which anticipated that it would require an estimated annual subsidy in the range of £103 million over the first seven and a half years. The current estimates suggest that the actual annual subsidy will exceed £620 million and could be as high as £1 billion. Private finance has proven to be enormously expensive without compensating benefit.

  The VfM analysis of the preferred bids has been manipulated in favour of the PPP and against the public sector alternative.

    —  PwC's VfM analysis penalises the PSC using performance adjustments based on a number of questionable judgmental factors, including the arbitrary assumption that the public sector should be expected to fail to meet the performance requirements required of the bidders.

    —  The advantages of bond financing as a basis for a PSC have been largely dismissed despite the significant efficiency gains and interest rate advantages of public finance. Bond financing is dismissed on the basis of its questionable impact on the borrowing cost for other public sector projects, known as "reputational externalities". Deloitte and Touche concluded that the rationale for such an adjustment was largely theoretical and the adjustment should be very small. However, we are encouraged to note that the Government has now belatedly embraced the idea of raising funds on the capital markets for infrastructure improvements as part of its solution to the Railtrack debacle.

  The Government promised the PPP would not go ahead unless value for money is demonstrated but has assigned the task of "proving" value for money to LT's financial advisors who are the architects, sponsors and promoters of the PPP. It is apparent that their findings lack credibility yet this appears to be the basis upon which the Government proposes to commit billions of pounds of taxpayers' money. Value for money must be determined prior to contract award by an independent and disinterested party.


  TfL has recently submitted a detailed consultation letter on contract terms. The following issues are particularly chilling in the light of the Railtrack fiasco:—

  A new and remarkable provision has been added to the PPP contract that insulates the Infraco from any meaningful obligation to provide finance after the first seven and a half years.

    —  This means that if the Infraco does not obtain new finance commitments before the seven and a half year review date, TfL must either rreduce the Infraco's obligations to rehabilitate the Underground so that no financing is required or provide the necessary financing itself. In this situation the public will not have the benefit of Infraco finance but will still have the extraordinary burdens and restrictions imposed by the PPP for an additional 22 1/2 years.

  The contract does not pass the risk of performing to the bid price and for cost overruns to the private sector.

    —  So long as the Infraco can justify the manner in which it manages the work as "efficient and economic" it bears less than £30 million in budget overruns per year. Any overruns over £200 million over the full seven and a half year period will be paid by the public purse through LUL. Unlike Railtrack, where the Government had the option to say no to additional subsidy, the Government (or TfL) will have no choice under the PPP.

    —  Infraco's bid "price" for the last 22 1/2 years of the contract will bear no relation to the price that LUL will actually pay for those years. Instead, the parties must renegotiate or seek a third party view as to what an "efficient" (at year seven and a half) Infraco should be paid for the expected (but not binding) scope of work.

    —  The risk assumed by the Infracos is limited to their equity investment. Unlike the standard Private Finance Initiative (PFI) model, the PPP contract does not require the basic protections of either parent company guarantees or performance bonds.

  If PPP fails the public has no realistic way out of the contract.

    —  TfL has asked for a "public interest termination" clause to be included in the PPP contracts to give it the option of buying out the contract (with Government consent) if the PPP fails. Remarkably, despite apparent bidder acceptance of this concept, this proposal has been rejected by the Government because it might suggest a lack of confidence in the PPP.

    —  Even if the Infraco utterly fails and defaults, LUL has no right of termination or reacquisition but can only invoke a lengthy and complex process to force the Infraco to sell to new owners, even if the structure of the entire arrangement has proven to be unworkable.

    —  With Railtrack the Government was finally able to pull the subsidy plug so that a restructuring could be attempted. In PPP, LUL might well find itself in breach of its contractual obligations if it refuses to bow to ever-spiralling subsidy demands. The only way out would be for LUL to default on its obligations. If it did so under the PPP contract, payments to shareholders could be five to 10 times the levels now being discussed for Railtrack investors.

  Once contracts have been signed, LUL's rights will be severely constrained.

    —  LUL will have no meaningful role in the Infraco decision making or selection of investment priorities. Infracos are free to depart from asset management plans supplied to LUL and have no contract obligation to actually deliver the specific investments suggested by their bids. LUL is also denied conventional rights to vary the Infracos' scope of work. Contrary to the Government's assertions that the PPP does not involve "privatisation or part privatisation of the Tube", the Infracos' long term control over the Underground infrastructure, coupled with their long term economic interest in that infrastructure, indisputably vests the Infracos with ownership of the infrastructure during the 30 year term of the contract (even if technically title to the assets remains in LUL). For all substantive purposes, the Infracos' interest in the Underground infrastructure is indistinguishable from the interest Railtrack had in the railways infrastructure, and does represent privatisation.

    —  LUL will have no opportunity to adjust the contracts until the seven and a half year review. Given that the Infracos will then effectively be in a monopoly position, LUL's ability to negotiate meaningful adjustments will be limited.

    —  The key role of the Arbitrator is to determine contract pricing at the seven and a half year review. The ability of the Arbiter to perform this function will depend on both the quality of the information then available and reference to comparable businesses. As there really are no comparable businesses (except the other two Infracos) and all relevant commercial information can be tightly controlled by the Infracos, LUL's ability to make any informed submissions to the Arbitrator will be limited and the Infracos will be free to exploit their monopoly positions.

  TfL supports and endorses the Mayor's commitment to transparency. The public has a right to see and understand the extraordinary concessions which are being handed to the private sector on its behalf. "Commercial confidentiality must not be used as a cloak to deny the public's right to know[9]".


  Annexed to this memorandum is a copy of TfL's Proposed Management Plan for the Underground[10]. It is significant that this document, published in April 2001, addresses all of the key issues identified by this Inquiry as important to maximise the service provided by the Underground. It is even more significant that TfL's alternative bears striking similarities to the evolving model proposed for Railtrack involving, as it does, a not for profit trust to raise funds on the capital markets with such funds to be supplemented by Government grant. Of particular interest are:—

    —  TfL proposes a simple but highly structured and tightly disciplined management structure which has worked in other transport systems around the world. The defining feature of TfL's proposed model is its clear structure of accountability affording the public owner unified control over the entire system. In TfL's professional judgement, this is essential for passenger and staff safety. This sits in stark contrast to the PPP model in which public control over the Infracos' activities is limited and relies upon unwieldly contractual mechanisms embedded in 135 separate contract documents, in excess of 2,800 pages of contract terms with 2,000,000 words.

    —  TfL's proposed financing programme and management structure is designed to allow the public owner to set and enforce clear and achievable performance targets on the Underground, at the lowest borrowing cost. This would be achieved in a coherent manner, prioritising the areas in most need of rehabilitation to assure safety and deliver a tangible improvement for passengers in the short term. TfL's model also provides sufficient flexibility to allow the public owner to react appropriately to unforeseen circumstances.


  PPP was misconceived at birth. The procurement is now nearly four years old and has failed to elicit real support from the public, transport experts or even PFI practitioners. Despite the consumption of over £200 million pounds worth of professional advice (and rising) PPP still:—

    —  fails to deliver the savings promised to Parliament at the outset and will not provide value for money when compared with a fair estimate of the public sector alternative;

    —  fails to improve passenger safety;

    —  fails to provide meaningful risk transfer while at the same time ensuring enormous profit opportunities to the private sector; and

    —  will be unmanageable because of its utterly convoluted contract regime.

  The good news is that there is a way out. TfL stands ready to implement its alternative plan which will deliver the improvements to the Underground that are so desperately needed. We call on the Government to transfer LUL to TfL so that the job of rebuilding the Underground can commence.

Robert R Kiley

Commissioner of Transport for London

12 October 2001

8   Attached memorandum marked "A" details the PPP timetable from May 1997 to date. Back

9   Cabinet Office-12 guiding principles in using Market Testing and Contracting Out. Back

10   Not printed. Back

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