MONDAY 18 NOVEMBER 2002

__________

Members present:

Mr Edward Leigh, in the Chair
Mr Richard Bacon
Mr Ian Davidson
Geraint Davies
Angela Eagle
Mr George Howarth
Mr Brian Jenkins
Mr George Osborne
Mr David Rendel
Mr Alan Williams

__________

MR TIM BURR, Deputy Comptroller and Auditor General, and MR JEREMY COLMAN, Assistant Auditor General, further examined.

MR BRIAN GLICKSMAN, Treasury Officer of Accounts, HM Treasury, further examined.

REPORT BY THE COMPTROLLER AND AUDITOR GENERAL

The Public Private Partnership for National Air Traffic Services Ltd

Examination of Witnesses

MS RACHEL LOMAX, Permanent Secretary, and MR IAN McBRAYNE, Head of Civil Aviation Division, Department for Transport; MR RICHARD EVERITT, Chief Executive, National Air Traffic Services Ltd, examined.

Chairman

  1. Good afternoon, ladies and gentlemen. Today we have a very important and serious subject. We are discussing the National Air Traffic Services which have been undertaken by a Public Private Partnership and there is considerable interest in this issue. We are delighted to welcome Rachel Lomax who has in the past been before us running a different department, but we congratulate you on taking on Transport earlier this year. Could you introduce your colleagues?
  2. (Ms Lomax) Mr Richard Everitt, the chief executive of NATS, is on my right and on my left is Mr Ian McBrayne from the Department, who is the head of the civil aviation division.

  3. You have adopted a not for profit company solution for Network Rail or your Department has. Why did you object to it for NATS?
  4. (Ms Lomax) This was discussed at great length when the Transport Bill was going through the House and I think the Treasury sent a memorandum to the transport select committee. At the time, the government felt that a PPP would provide a stronger commercial framework and would promote more efficiency than the untried and untested not for profits model which had only very recently been adopted in Canada. With the benefit of hindsight and given the strategic partner we have ended up with, the difference between the PPP and the not for profit model is perhaps not as great as people thought at the time.

  5. If you were making this decision now, a not for profit company might have been more of a runner?
  6. (Ms Lomax) The arguments would have looked a bit more finely balanced, yes.

  7. The Treasury were raising 500 million from this sale. In the event, you raised 800 million. This was raised mainly by debt which had to be repaid by NATS itself. Did the desire to take this much money out take priority over the long term viability of the deal?
  8. (Ms Lomax) No. On the minor point first, the Department had no benefit at all from the receipts being so far in excess of the 500 million that had been taken into account at the time of the Comprehensive Spending Review. Naturally, the Department was concerned to get value for money for the taxpayer and was mindful of the points which have been made in this Committee about the need to do that. The major objectives of the PPP were to provide a viable way forward for NATS and to ensure that the concerns about safety, security and public accountability that had been expressed in Parliament were adequately addressed.

  9. The airlines in the end put in very little money. 60 million?
  10. (Ms Lomax) It was a highly leveraged structure that emerged from the PPP negotiations. It would have been the same if it had been any of the other bidders at that stage. This was pretty much in line with the sort of structure for regulated utilities that other sectors were adopting at that time. The water sector, for example, followed the lead of Plas Cymru. That very highly leveraged structure was something that was popular with other utilities.

  11. In the event, we know that the whole thing has turned out very badly because of a sustained downturn in traffic. Why did you not test the robustness of the Airline Group's financial structure against a possible downturn? After all, there had been downturns in the past.
  12. (Ms Lomax) There has been nothing on the scale and the severity of the downturn that followed 11 September. In terms of its impact on NATS' business, which is very dependent on large, long distance aircraft to generate income, in terms of chargeable service units, this downturn has been way in excess of anything that has been seen before. For example, the downturn following the Gulf War on a year on year basis in chargeable service units was one per cent. For the last 12 months, it has been 11 per cent.

  13. You could have coped with the downturn you had after the Gulf War. That was the scenario you were looking at, was it?
  14. (Ms Lomax) Yes.

  15. You did look at these scenarios, did you?
  16. (Ms Lomax) It was very extensively stress tested. Every scenario that people could think of to throw at these models, these bids, was worked up. There were compulsory ones which our advisers suggested. Each of the bidders devised their own and we also did some in-house. That is not to say that every possible scenario that anyone could ever think of was tested because life is not like that. The honest truth is that, in the circumstances of the time, the world looked a less risky place than it does today.

  17. Your advisers, CSFB, were giving you this useful advice about a possible downturn? You were paying them a lot of money, were you not?
  18. (Ms Lomax) Yes, and they did a very great deal of work for it. Every year since data on chargeable service units has been collected, since 1983, there has been growth in that measure of particular relevance to NATS, with the exception of the Gulf War when, as I mentioned, there was a relatively small downturn. It had been a very strong, consistent picture in upward growth in that market.

  19. Your "partner", the Airline Group, have refused to put any more money in to produce more equity for NATS. It has been left to you to bail them out with 60 million of temporary finance. You are letting the airlines off very lightly, are you not? If there had not been this downturn, they would have got a profit. Now that there is a massive loss and we are in this appalling mess, they are walking away from it, are they not?
  20. (Ms Lomax) September 11 has hit the aviation sector very hard, including the Airline Group. It is a question of what they can afford to do. The taxpayer is not picking up the whole consequence.

  21. You and the banks, I should have said, are finding 60 million?
  22. (Ms Lomax) Neither are users. The 60 million that you are talking about was a temporary facility that was put in place earlier this year which ran out at the end of September and has not been used. What is being worked up at the moment is a more lasting solution which the CAA and NATS are actively discussing. The CAA put out a consultation paper in the middle of October which has been out to consultation until last week. We are expecting a decision from them in a few weeks' time. The principle that they have adopted is that all parties -- users, the government and the banks -- should be making a contribution to a lasting solution.

  23. Mr Everitt, obviously you have a very good safety record. I do not think there has ever been a fatality in the UK because of a failure in air traffic control. Will this good performance be sustainable in the future given your difficulties in investing?
  24. (Mr Everitt) Yes. I am determined it will be sustained and indeed improved. Our performance this year in terms of risk bearing air proxies is similar, perhaps slightly better than last year, although they have not been all fully assessed by the Aircrafts Board, which was in single figures. I am determined to improve on that. This is our absolute priority. That is what we are here for and whatever the financial situation we are determined to work on our safety record.

  25. That is fine as far as it goes but you are also required, are you not, in your job to increase capacity? Because of the financial difficulties you find yourself under, you have not been able to do that at present. To what extent are you now being constrained in what you might have hoped to achieve over the next decade? When there is an upturn, we are going to find there will be severe delays because you simply have not the resources to put the investment in.
  26. (Mr Everitt) We have Swanwick and we have brought Swanwick into use very successfully in January. That is one of the principal drivers of our future capacity. The way we will increase capacity over the near term is to increase the number of sectors. Airspace is broken up into sectors, which enables us to distribute the work amongst a greater number of controllers. We are doing a major resectorisation which we anticipate coming on stream in March, which will give us additional capacity in the North Sea which is one of the big pinch points we have at the moment. It will also meet some military needs. We have not stopped growing capacity. We will also grow capacity through the Swanwick system as we bring additional controllers in. Where we have paused -- and I stress "paused" -- is in investment in our future sensor systems, but we have used this year to really think through the risks and the opportunities and how we might collaborate on future sensor systems. I am confident that once we are through this refinancing following the CAA's decision we can get on with some of these projects.

  27. We know from paragraph 3.11 of this report that the project to increase air traffic capacity could take several years to implement. Are you telling us that the lack of investment that we are now seeing and the difficulties out there will not lead to a risk of demand exceeding capacity?
  28. (Mr Everitt) I am reasonably confident that that is the case, as long as we can get these issues resolved in the next few months. We will have better projects. One of the things the PPP was set up for was to improve the project process within NATS and we have used this year to really think through what we can do and how we can manage the risk of these very, very complex projects more effectively. We have used this year well. What we now need is the composite solution to be put in place so that we can continue to move forward. I would stress that we spent, in the last financial year, 64 million on capital. This year, we will spend about 50 million, so we have not just stopped spending. We have just been careful how we use our money, given that we have had to lift our cash flow now for nearly 15 months.

    Mr Williams

  29. I want to establish to what extent the Treasury was in the driving seat. I ask this because the supplementary briefing we had just before the meeting updating us from the NAO makes the point that the Department and the Treasury decided to address the problem through a PPP. It says that the Department and the Treasury dismissed the option of a not for profit company. How much alternative did you really have as a Department? Was there any option on the table other than a PPP?
  30. (Ms Lomax) It is not a question that I think I can answer. It goes to the question of discussions that were going on between ministers and departments which, even if I had been party to, I would not want to reveal. On a major, controversial issue like this involving the ownership of a safety critical industry like NATS, I would be most surprised if the Department just did it off its own bat. It really does need to be agreed with the Treasury.

  31. So that this is not taken out of my time, on a point of order, Chairman, I make the point that we have just had a witness who was not the Permanent Secretary at the time saying that she cannot answer because she was not there at the time. At an earlier meeting, I did ask that we have at this meeting the Permanent Secretary who was there for four relevant years. We do not have him here so I would hope that subsequently, at the end of this meeting -- it is not your fault, Permanent Secretary -- we can address this problem of us not being able to get answers because we have the wrong witnesses. That is not to in any way undermine the respect we have for the current witness. Looking through the report, I seem to miss a public sector comparator. Was there a public sector comparator?
  32. (Ms Lomax) The way I see this ----

  33. Was there or was there not? We either have a comparator or we do not have a comparator. For all the others, we have had a comparator. It could be a fault on my part but I have not seen one in here and you have not seen one either, have you?
  34. (Ms Lomax) No, I have not seen one.

  35. In that case, it is not for you to answer because we can now go to the Treasury. Why are we in the situation where there is not a meaningful public sector comparator?
  36. (Mr Colman) For many years, privatisations took place without any form of public sector comparators.

  37. I am asking why there is not one in this case. This is particularly sensitive, being a highly political trail in advance. There was considerable criticism of the possibility of going this route. Why did you not protect the back of the Department and the Treasury by having a public sector comparator or did you not dare do it?
  38. (Mr Glicksman) I have not seen a public sector comparator. I cannot answer your question directly.

    (Ms Lomax) I do not think I would expect to see a public sector comparator in a case like this. You see them for PFI deals but I have never seen one for a privatisation. This was a share sale of 51 per cent of the shares. It was a major policy decision and it went through the Houses of Parliament. The trouble about PFIs is that they do not have that sort of political scrutiny.

  39. You did not have one and I have established that quite clearly. This was all about obtaining a one billion investment and you have been talking of 60 million last year and 50 million this year. You still have a very long way to go. The consortium paid 65 or 50 million? It is 46 per cent of the business. If you look at table 11 the 65 million is made up of 50 million equity from the Airline Group and an additional loan. A loan to whom from the Airline Group and who was to pay it back? That made the 15 million to make it up to 65. What did they pay? 50 million or 65 million?
  40. (Ms Lomax) They paid 50 million for an equity stake and then there was a 15 million loan from British Airways.

  41. To who?
  42. (Ms Lomax) It was paid into NATS.

  43. Who pays it back?
  44. (Ms Lomax) NATS will pay it back.

  45. In other words, all they paid was 50 million to get 46 per cent of the whole of this business?
  46. (Ms Lomax) Yes.

  47. That is absolutely unbelievable. That left NATS lumbered with a debt of 735 million which was quoted as part of the purchase price, although the purchaser never paid it, because you are having to pick up this bill, are you not, NATS?
  48. (Mr Everitt) Yes. It is a debt of the company.

  49. That is 735 million you are paying for them to buy your business. What about the interest on that 735 million? That does not include the interest charge as well, does it?
  50. (Mr Everitt) Yes. We have a loan put in place as part of the restructuring of the finances of the company at completion. It is our job as a company to service that loan both in terms of interest and to repay it.

  51. You are paying the interest as well?
  52. (Mr Everitt) Yes.

  53. Over 20 years, if it were ten per cent, that would be another 800 million and it is probably more than that, is it not?
  54. (Mr Everitt) I think the interest rate is around seven per cent.

  55. In that case, it is 600 million. In addition to paying back the 800 million, you are also lumbered with 600 million of interest charges, all to enable someone else to buy your business.
  56. (Mr Everitt) It will be quite a lot less than that because we will be paying back part of the loan over the 20 years.

  57. The average loan is 400 million. In 20 years it is 600 million so you are paying 1,400 million for someone else to buy half your business effectively. That is correct, is it not?
  58. (Mr Everitt) The two shareholders, Her Majesty's Government and the Airline Group, structured the finances of the company at completion and determined that they would put this amount of debt in place. That represented the proceeds to the government ----

  59. That is not answering the question. The fact of the matter is that you are lumbered with a debt which is now making it impossible for you to borrow on the market even as easily as you could have done before the PPP. That is a fact, is it not?
  60. (Mr Everitt) We have a large debt and that is making it difficult.

  61. You are in a worse position than you were before you had a PPP and you are saddled with paying for someone else to buy it. Permanent Secretary, when this was up for grabs, did the bidders know that they would be able to offload the loan -- I assume they must have done because it was part of the discussion -- onto NATS?
  62. (Ms Lomax) Yes.

  63. One of the puzzling things is that the Treasury, who are usually pretty good at working out what they might get from a sell-off, were expecting 500 million. They got 800 million and they could not believe what was in their greedy little hands. Does it not in a way explain the situation because if the bidders knew that they could bid and it did not matter what they bid; NATS would pay, they could keep up bidding knowing NATS would pick up the bill. What the Treasury got was an actual receipt from a most deceptive and non-competitive way of selling a business on.
  64. (Ms Lomax) There is a limit to the amount of debt that people would have saddled with NATS and that is the amount of debt which NATS was thought to be able to service out of its income. That is why the deals were structured in this way, because it was thought to have a very strong income revenue.

  65. Who represented the purchasers?
  66. (Ms Lomax) The Airline Group.

  67. Yes.
  68. (Ms Lomax) They are not here.

  69. That is another witness we could have done with. We are not doing very well at all today.
  70. (Ms Lomax) The Airline Group put the bid in on the basis that they would not be taking dividends out. They are not looking to make a profit out of this.

  71. You do not get 46 per cent of a business when you have only paid one-sixteenth on purchase price. When you take into account that it is then a further twelfth it is also the interest element which brings us up to 14 million. It is one pound every 20-worth of purchase.
  72. (Ms Lomax) There is an issue about how much a business carrying this much debt is going to be worth. The equity shareholders are the last in line. If the business is very encumbered with debt, there is going to be less for them even if they were going to take dividends out.

  73. Treasury, since you only expected 500 million, why did you take the 800 million? Why did you not leave the other 300 million in to reduce the debt and therefore give NATS more flexibility?
  74. (Mr Glicksman) 800 million was the amount that was offered by the best bid. It would be quite difficult to go back to them and say, "This is too much. We do not want so much money for this sale." What we were looking for was best value for money and there is no reason why this should not have been the best value for money.

  75. It is the most flawed project I think I can ever remember coming before this Committee.
  76. (Ms Lomax) Two valuations were done of NATS by Price Waterhouse Coopers as well as by CFSB, our advisers. They put the value of NATS at somewhere between 800 million and a billion. I would be in a very uncomfortable position indeed if I had come before this Committee and said that we deliberately decided to take 500 million when that was the valuation sitting on the table by our advisers and independent valuers, supposing September 11 had not occurred. It is very difficult to justify to the Public Accounts Committee accepting a bid so far off the valuation that the market is putting on it.

    Mr Rendel

  77. Ms Lomax, is NATS going to survive in its present ownership pattern?
  78. (Ms Lomax) I think so, yes. There is a refinancing going on at the moment as part of putting a composite solution in place, but by and large the PPP has emerged pretty well over the last year.

  79. You are confident that we are not going to see another railway situation in which, in effect, the government has to take the thing back into public ownership?
  80. (Ms Lomax) That looks unlikely at the moment, yes.

  81. You said in answer to the Chairman, when he asked whether you tested for a downturn in the business, "There has never been a downturn on this scale" and that it was very extensively stress tested and that every scenario that people could think of was worked up. Could I ask you to look at page 38, figure 21, where you will see that, according to the NAO there was a number of scenarios tested by the Airline Group over and above those that had been requested, but a number of historic scenarios were not remodelled, including those three on the right there, the first oil shock, the second oil shock and the Gulf War. Presumably if those are historic scenarios, somebody could have thought of them and yet you said that every scenario that people could think of was worked up.
  82. (Ms Lomax) The question that I think was asked, which is not exactly the same as testing these scenarios, was what sort of shock to airline traffic would cause this deal to fall apart. As I understand the advice given to me when I have asked this question, the answer was such a large shock that it was thought to be quite implausible.

  83. I do not think that was the question. What the Chairman asked you was why did you not test for a downturn in business. You said that there had never been a downturn in business on this scale, which I understand, but there have been significant downturns in business, including the ones which showed that, for a few years at least, there was very little growth in air traffic as in the first oil shock and the second oil shock scenarios given here. Clearly, if those had been tested for, it would have given a very different picture of the ability of NATS to retain the chance to invest in the future and to take on more debt, which we now find it cannot take on.
  84. (Ms Lomax) I do not think that is quite right. I think that downside scenarios were tested.

  85. Not these.
  86. (Ms Lomax) There was a prolonged period of low growth and individual shock in one year on the same scale as the Gulf War, which I am told we did test for.

  87. If you look at the fifth column, "Lower Traffic in Year 6", I understand that it was insisted that they do a certain amount of testing of three per cent growth as opposed to six per cent growth, or seven per cent; I forget. Anyway, it is still growth of a considerable amount, whereas if you look at the scenarios, first oil shock and second oil shock, you get effectively no growth for three or four years. In the first oil shock case, you actually get a downturn and a positive drop in air traffic for the first four years.
  88. (Ms Lomax) These are flights as opposed to the chargeable service units. These are not comparable data for ----

  89. On the left hand side it says "chargeable service units".
  90. (Ms Lomax) I do not think they can be for the first and second oil shocks because comparable data do not exist before 1983.

  91. You appear to be saying that this report is wrong. If it is wrong, you should have said so at the time.
  92. (Ms Lomax) I think it actually says ----

  93. Could I ask the NAO?
  94. (Mr Colman) I am as puzzled as you are. The chart is what it says, chargeable service units, and this report has been agreed in detail with the Department.

    (Ms Lomax) I do not want to make a big thing about this because I think there are general points to be made. I am told you did not take account of all our comments.

  95. Chairman, this seems to be quite serious. The witness is saying that she claimed that the report was wrong and that this has not been taken into account by the NAO. Therefore, there is still a conflict, apparently, between what the Department and the NAO are saying as to the truth of this report.
  96. (Ms Lomax) The important point to make is that very large numbers of scenarios were tested. They did include some downside scenarios. The ones that were tested ----

  97. Before we get back to that, there is a point which I want to investigate further as to what this means. The first thing we have to get at is whether this report is accurate or not. As far as I can understand the NAO, the NAO still thinks it is accurate. Are you saying that you hold that it is not accurate and that you told the NAO this and that, in your view, there is still a difference of opinion between yourselves and the NAO and yet this report has been allowed to go ahead?
  98. (Ms Lomax) I do not want to pursue this.

  99. I do want to. It is a very important point.
  100. (Ms Lomax) It may be me who has got this wrong. I would much rather ----

    Chairman

  101. Do you want to take a minute to take advice?
  102. (Ms Lomax) Can we write to you? We think it is flights that the data are showing here. If we failed to pursue the point sufficiently vigorously with the NAO at the time when we should have done, I apologise to the Committee. We need to beg the Committee's indulgence to follow this up afterwards. The general point I think I can make is that downside scenarios were tested. There was extensive testing by the bidders, by our advisers and for the benefit not just of the Department and the Treasury but also credit committees of four banks. This was a very thorough exercise. The issue that is worth thinking about is that, in the circumstances of May 2001, the world looked a safer place. The expectations for that traffic growth were different. Even if you had said that there could be an absolutely catastrophic development of the sort that September 11precipitated, how much weight would you put on that in deciding what was an acceptable price and an acceptable financial structure for NATS?

    Mr Rendel: Chairman, I understand what the witness is saying but this is a serious matter. We have come up, apparently, with a disagreement between the NAO and the witness as to whether this report is accurate or not. It does make a difference to my further questioning because clearly if this report is accurate and what the witness was saying earlier in answer to you was not accurate, if she is now correcting what she is saying about this and the NAO have made a mistake, obviously that makes a difference to any further lines of questioning. We may wish to discuss afterwards as to whether we need to recall this witness at a later stage to answer these points once she has been able to hammer out with the NAO what is the truth of this matter.

    Mr Williams: Or recall the Permanent Secretary who was there at the time.

    Mr Rendel

  103. I am a little unhappy that this should be answered by a note.
  104. (Mr Burr) Whatever these are, the point still remains that the scenarios in blue did not exhibit the patterns of the scenarios in grey.

  105. I entirely take the point there but it seems to me that what the witness is saying is that the blue scenarios were calculated on a different basis from the grey scenarios. Perhaps we can go on with some other questions. To what extent do you feel that the privatisation transferred any risk of further problems from the public to the private sector or was it never intended to do that at all?
  106. (Ms Lomax) The risk has clearly been transferred in the sense that, had NATS remained in the public sector, there would have been a choice of two possibilities to respond to the events of September 11. One, the government could have picked up the whole tab. Two, the costs could have been passed straight on to users. The whole business about the composite solution is an attempt to find a way of spreading the adjustment across a wider collection of people.

  107. May I ask you to turn to page 26, figure 14, because it indicates that the difference between the Airline Group and the Nimbus Group came out better in terms of Nimbus on three of the different criteria and better in terms of the Airline Group on two, of which one was the net sales proceeds. To what extent was it net sales proceeds that made the difference to the choice? Was that really your main criterion?
  108. (Ms Lomax) No. The choice was made in the round. There was a small difference between the Airline Group and Nimbus at the end but it was only a few million. The Nimbus deal was different because Serco wanted to put their existing ----

  109. What was the difference of a few million?
  110. (Ms Lomax) By the time the Airline Group's bid had been adjusted down, the difference in terms of the net sales proceeds between the Airline Group and Nimbus was quite small. The Nimbus Group also involved a great deal of debt for NATS, by the way, but it was different in some other respects.

  111. Better in some respects?
  112. (Ms Lomax) Yes, and also worse in some respects.

  113. Including financial credibility and capacity, which sounds like exactly why the NATS bid has gone wrong.
  114. (Ms Lomax) There were differences across all the criteria. For example, certainty, clarity and conditionality. Nimbus was rated acceptable to poor.

  115. Am I right in saying that effectively what happened was that the Airline Group, having been made the prime bidder, was able to gazump the government downwards at the last minute, when it was rather late to change your mind, and yet you suddenly discovered that they were offering a lower price for your goods than they had previously offered you?
  116. (Ms Lomax) Nimbus did volunteer that they did not want to change their bid. This was against the background of foot and mouth and the impact that that was having on traffic forecasts.

  117. You were gazumped?
  118. (Ms Lomax) We prudently took account of what was happening in the outside world and I think we would have been criticised if we had not. Traffic forecasts were coming down. The questioning so far has suggested that we were so greedy for proceeds that we did not look hard to see whether it was a safe deal. We did take account of the fact that the world was changing and that the world economy was slowing, that foot and mouth was hitting the North Atlantic trade quite severely and that those were good reasons for allowing the Airline Group to revise its forecast down. Even so, it remained higher than the Nimbus Group and the Nimbus Group voluntarily decided they did not want to adjust their bid.

    Chairman

  119. That was rather a frustrating session because you signed off this report. When Permanent Secretaries sign off a report, we assume the departments have agreed the report. Either the Department signed up to this report and every fact, including the figures, or it has not. Otherwise, we get into a ridiculous situation. Are we basing our questions on inaccurate reports? Colleagues are frustrated. Personally, I am in the dark now. I asked you a simple question at the beginning of this meeting: did you take account of possible downturns? You said, "We could not possibly have foreseen there being a downturn after September 11." That is a fair enough answer. As I understood it, you said to me, "Yes, we did take account of what happened in the Gulf War and the oil shocks of 1973 and 1972." There now seems some doubt about this. I do not know about colleagues but I, for one, am confused.
  120. (Ms Lomax) Could I have a shot at explaining? First of all, I apologise for appearing to criticise anything in the report at this stage. I should not have done it. It is out of order. The truth of the matter is that the amount of technical testing for a bid like this is enormous. The NAO report may not be inaccurate so much as over-simplified. I stick completely to what I said to you at the beginning, which was that the impact of September 11 on the measure of airline traffic that matters to NATS' income was quite unprecedented. For the purposes of considering the present situation, that is a very important point. With the ink scarcely dry on the contract, with the PPP only seven weeks old, NATS was hit by a quite unprecedented shock.

    Chairman: I am not sure that answers my question. I have made my point. You have promised us a note. I do not really like dealing with notes because it is much better to resolve these things. Maybe, before the end of the meeting, we will get to the bottom of it. If we have not, I will ask you some more questions.

    Mr Osborne

  121. Can I turn to the answer you gave to the Chairman earlier about, to quote, the judgment now between a not for profit solution and the PPP would be more finely balanced with hindsight. Would you elaborate on that?
  122. (Ms Lomax) There are two relevant points. One is that the NAVCANADA model, at the time when it was being cited as something that we should look to in structuring the future for NATS, was relatively recently introduced. It came in in 1996. It was difficult to use that. It was not a tested model. In practice, it turned out rather well. The second thing is that the strategic partner in the PPP is the Airline Group which has said that it wants to operate on a not for profit basis and it will not be looking to take dividends.

  123. It is doing a good job of operating on a not for profit basis at the moment.
  124. (Ms Lomax) I think that is very similar to most people in the aviation sector, is it not?

  125. Your view is that it is now a more finely balanced decision between a not for profit organisation and a PPP; whereas at the time this legislation was going through Parliament it was amongst the most controversial legislation of the last Parliament. There was an enormous row about whether a not for profit solution would be better. You are now in effect saying that, with hindsight, you are not sure; maybe it would not; whereas the statements from ministers at the time were that the case for the PPP was overwhelming.
  126. (Ms Lomax) The PPP is there. A lot of work has gone into it. It has been very carefully thought through. I was asked to say how could we therefore be going ahead with Network Rail which is a not for profit structure and I have indicated that people's minds are not closed on it. It was not a theological thing.

  127. My colleague says it seemed like it at the time. If you read this report, paragraph 1.7, page 12, the very last bit of the paragraph says, "The Department worked on the understanding that in the United Kingdom the particular structure of NAVCANADA would not result in NATS' expenditure being classified to the private sector and would not therefore provide the freedom to invest that was required." In other words, a not for profit NATS would appear on the Treasury's books. I am right in saying that Network Rail does not appear on the Treasury's books?
  128. (Ms Lomax) If I could read the next sentence: "However, any definitive view would be subject to detailed assessment of the body's control and risk transfer arrangements." The same is true of Network Rail.

  129. Once you had a detailed chat with the Treasury, you were able to put Network Rail off the Treasury's books.
  130. (Ms Lomax) The decision to classify Network Rail the way it is does reflect particular opposition that has been put forward by Network Rail about control.

  131. There does not seem to be a great deal of difference in principle between a not for profit operator of an air traffic control system and a not for profit operator of a railway system. The principle of the government's relationship with a not for profit organisation is there.
  132. (Ms Lomax) One significant difference is that Network Rail is in receipt of a large amount of public subsidy; whereas NATS is not.

  133. Relatively speaking, it is receiving quite a lot of soft government loans, is it not?
  134. (Ms Lomax) Is it? What soft government loans? It is not in receipt of any soft government loans.

  135. It got 30 million earlier this year.
  136. (Ms Lomax) Are we talking about Network Rail or NATS?

  137. NATS. Was it not bailed out in March?
  138. (Ms Lomax) No, not at all.

    (Mr Everitt) In March a 60 million facility was put in place on commercial terms, subscribed 50/50 by the banks and the government. That was designed to be working capital. It expired and was repayable by the end of September. We did not have to draw on it. Had we had to draw on it, it was on straight commercial terms.

  139. Why did you need the government as a partner? Why not go to the banks for the whole amount?
  140. (Mr Everitt) That was the arrangement that was put in place between the government as shareholder and the banks as funders. It was done on strict commercial terms because the banks would not do it in any other way.

  141. Are you considering now a not for profit solution? Have you decided that now you have the PPP, come hell or high water, you are going to stick with it or are you considering another major change?
  142. (Ms Lomax) No, we are certainly not thinking of another major change. There is no need to at the moment and having gone to so much time, trouble, parliamentary time and money to construct the PPP it would be a very serious decision indeed to abandon it.

  143. Have you contingency planning in place in case, for example, revenues do not pick up and the downturn is more prolonged than you anticipate?
  144. (Ms Lomax) The structure of the PPP and the economic regulatory framework within which it is operating does provide for recourse if NATS gets into difficulties. For example, there is in the NATS licence a condition which provides for an exceptional user contribution in circumstances which could not have been foreseen. Prices could be raised. In the legislation, as you no doubt recall, there is provision for air administration on the same lines as rail. There is a wide range of things which could be done if NATS got into serious difficulties, but that is not where we are at the moment. We are negotiating a restructuring which will put us on a firm footing even in these difficult circumstances.

  145. You are not doing any planning for those possible outcomes?
  146. (Ms Lomax) We have plans against almost everything in the Department.

  147. Some plans are more worked up than others.
  148. (Ms Lomax) At the moment, we have reasonable grounds for supposing that a composite solution will be in place shortly.

  149. One of the major cases for a PPP originally was that in the public sector NATS would not be able to get hold of the money needed to invest in new equipment, new capital and so on. I think Mr Everitt was saying that you were rather proud that your capital spending was 64 million last year.
  150. (Mr Everitt) That is right.

  151. What were you hoping to spend in a pre September 11 world?
  152. (Mr Everitt) Not a great deal more than that. The big issue would have been the speed with which we could move on the Scottish centre. We had already made decisions prior to September 11 that we needed to review that project. As I explained to the Chairman, we have spent this year examining what our best options are and particularly how we can collaborate more closely with key partners in Europe. I think we are making good progress on that, so I would be surprised if it would have been a great deal more.

  153. In paragraph two of this report on page one, the summary page, it says, "In 1997 NATS estimated that it required some 100 million of further capital investment every year for the next decade to increase air traffic control capacity to meet future traffic growth." Originally, back in 1997, you were looking for 100 million in capital investment a year and this year you are on half of that, are you?
  154. (Mr Everitt) Yes. It is a broad order number obviously, 100 million a year. Part of my job is to make sure that we spend money wisely and effectively. We have taken this year to really work through what our best options are on the capital programme.

  155. Could I ask you about one of those capital projects which I am sure you are very familiar with, which is the software system at West Drayton? Am I right in saying that this software was designed, if that is the right word, in 1975?
  156. (Ms Lomax) One has to be careful. I think software is developed. "Written" is the right word. It is written in a language, as I understand it -- I am not a technician -- which dates from that time. It is our flight data processing and is a very similar system to that currently in use in the United States, so we are not alone in that.

  157. It says in this report that you will be using elements of that software until 2011. Given the fact that it has completely crashed twice this year, have you brought forward plans to replace the software so that we do not have further crashes with possible catastrophic consequences?
  158. (Mr Everitt) Firstly, the hardware is modern. It is the software where we have the issues and we have resolved satisfactorily now the issues that we experienced earlier on this year. Part of the capital plan is a sequential move away from the existing flight data processing that we have, but it will take time to do. This has been an extremely difficult issue for both our colleagues in America to address and for NATS itself to address, because the whole system is in effect driven by the software. We have a group of internal experts who understand it broadly and we bring in external advice on how we maintain it. Swanwick brought in a new dimension which I could go into, but I know time is limited, and we had to address that dimension which is basically sequencing the Swanwick software with the West Drayton software. We have learned a lot in the past nine months, but it does remain one of our vulnerabilities. This is a very complex system that we are trying to operate. The capital plan will address it but we will not finally be through dependence on that software probably until 2011/12. We will reduce it over time.

    Angela Eagle

  159. Mr Glicksman, I seem to recall when the government first came to power in 1997 there was a left over from the previous government and that was an assumption of a 500 million capital receipt for the sale of NATS which was put into the departmental totals. Is that true?
  160. (Mr Glicksman) Yes, that is correct.

  161. We also had the decision that we were going to operate within the previous expenditure totals as decided by the last government. That is true, is it not?
  162. (Mr Glicksman) Yes, that is correct.

  163. There was a big hole in the expenditure or the income for the Department which necessitated raising moneys in order to fill the hole?
  164. (Mr Glicksman) I am not sure I would describe it as a hole.

  165. A lack of 500 million?
  166. (Mr Glicksman) There was a requirement to reconcile the public expenditure plans that were inherited with the government's contracts.

  167. That meant that there had to be an attempt to raise the money somehow, did it not?
  168. (Mr Glicksman) It meant that some way needed to be found to reconcile the two plans, yes.

  169. Which is the same as what I have just said, is it not? The only way that those plans could be reconciled was by gaining a capital receipt.
  170. (Mr Glicksman) A capital receipt would have enabled the plans to be reconciled, yes.

  171. Ms Lomax, I know you were not there but would a not for profit solution have gained the capital receipt?
  172. (Ms Lomax) I think so, yes. We could have got receipts which were not for profit. That is made clear in the NAO report on page 16.

  173. When, in NAVCANADA, that option was looked at, it appears that that was discounted because it would not have taken any subsequent investment off the government's books which is the Treasury rule.
  174. (Ms Lomax) What it says here -- and I have not seen anything to contradict it -- is that the department thought it would be difficult to ensure that NAVCANADA's particular structure would be classified as in the private sector so avoiding inclusion in public sector borrowing.

  175. And yet we have seen from subsequent events we have a structure that is reasonably similar to some extent because the current arrangements are that there will not be any dividends paid. You said at the very beginning that, given hindsight, which is always useful to have, the arguments between having a PPP and a not for profit solution are now more finely balanced than they were. Is it the case that the Treasury rules should be looked at because they often lead you to making a particular decision which you might not have made had the Treasury rules been slightly different?
  176. (Ms Lomax) It is not for me to comment on the Treasury rules but I think there were other reasons.

  177. Mr Glicksman?
  178. (Mr Glicksman) The rules are not the Treasury's. The classification rules are from the Office of National Statistics and the international rules the Office of National Statistics uses in deciding on the classification of public bodies.

  179. We sign up to them for accountancy purposes?
  180. (Mr Glicksman) For classification for the national accounts, yes, and statistical purposes in the case of the Office for National Statistics. The NAO report does not state that a not for profit solution would have been classified in the public sector.

  181. It was thought it would not at the time.
  182. (Mr Glicksman) As the report says, the definitive view would have been subject to a detailed assessment because it would have depended how exactly the body would have been structured.

  183. Mr Everitt, you have decided not to distribute dividends. Is that right?
  184. (Mr Everitt) We are not in a position to distribute dividends but the position of the Airline Group as shareholder is that they went into this on the basis that they would not seek a commercial return on their equity. At the end of the day, it will be for the board and the shareholders to decide on dividend distribution. There cannot be a prospect of that for some years.

  185. How happy were you taking on a structure where the debt was so large that you had to borrow effectively the entire cost valuation of the business from banks, such a small amount of 65 million effectively was put into buy it, the rest was all in debt to the banks?
  186. (Mr Everitt) I certainly looked at it. From a personal point of view I came into this job on completion of the PPP and looked at the testing that had been done against scenarios in the first two years and whilst it was clearly going to be tight it looked to be doable. The real change, of course, has been the unprecedented down turn since September 11.

  187. The aim or one of the reasons for doing this right from the beginning was the 100m a year of new investment that it was estimated the system needed to bring it up to the modern standards and keep investing in it. Is that going ahead as planned?
  188. (Mr Everitt) I have already answered that. We did 64 last area and we will do just over 50 this year. We clearly have to tailor our short-term capital investment to the circumstances in which we find ourselves, that is one where cash has had to be conserved while we go through the restructuring of our regulatory board, the restructuring of our finances, part of which is the application to the Civil Aviation Authority.

  189. Do you anticipate you will be able to keep ahead of the game?
  190. (Mr Everitt) In our business plan in two years we are planning to spend in excess of 100 million, yes. We will get back on track and I think we will be able to manage the risks much better.

  191. Ms Lomax, this is a huge undertaking, where a lot of modelling was given, where huge amounts of work went in, where 44 million of government money was spent on advice and a range of decisions had to be taken. Do you think on the whole that we have ended up with a better, more robust structure than we would have had if the sale had not happened and there had not been any restructuring?
  192. (Ms Lomax) There have been some very significant benefits from the PPP, even in the very difficult circumstance it has had to live with. For example every other air traffic control body in Europe and north American has responded to the down turn since September 11 by raising prices, sometimes by very significant amounts. That has happened because it is not subject to economic regulation, which is part of the PPP process, and that is a significant benefit. I think that the whole PPP process clarified and strengthened the safety framework in an important way. You can say, well it was not absolutely necessary but actually the process of developing the PPP meant that issues were addressed, like the safety frame works, in a way which I think put NATS in a stronger position. Those are just two examples.

    (Mr Everitt) We have also been able to attract new management, as it were, to complement the existing management, and that has been an important development.

  193. You have their services for remuneration.
  194. (Mr Everitt) One has to attract the right people and that has not been easy in the uncertainty we have been in, but it is critical for our future.

    (Ms Lomax) The real proof of PPP will come in the longer term because what it was really about was providing a sustained place of investment, which is something you can never be assured of in the public sector because there is always the risk of capital rationing in circumstances which are way beyond the concerns of individual public sector bodies. Over a period of time you ought to see a more sustained further investment into NATS and that will enable it to grow a culture in which people who are good can make a future, so we will get a stronger project management culture that will go with that.

  195. Given the constraints that NATS has in its structure, really its income is in the price it charges, are you comfortable with the fact that the regulatory system assumes downward pressure on prices?
  196. (Ms Lomax) I think that NATS has the highest charges in Europe by some margin as far as I can make out. Even allowing for the greater complexity of the airspace over the south east of England NATS charges are pretty high. It was believed in the aviation sector that there was scope for genuine improvements in efficiency. I think it has been under pressure to manage the position in the way that it has and it is not necessarily an unhealthy matter. The Regulator's first duty is to have regard to safety. I think that we have a framework which safeguards safety but also puts serious pressure on NATS to be more efficient.

  197. Mr Everitt, are you happy with that?
  198. (Mr Everitt) Yes, I think the regime that we have asked for - which is the RPI-2 for each of the next 3 years with an indication that that sort of level will continue into the next 5 year period, which starts in '06 - is a reasonable balance and will keep pressure on the business for efficiency. I think that is what our airline customers expect, indeed they hold us out as the model. If you talk to IATA or any of the representative groups this is the way they want to see air traffic control in Europe go. As the Permanent Secretary said we reduced our charges last January and we will reduce them this coming January. Very few major suppliers in Europe have done that. The average increase last year in Europe, last January, was 12 per cent in a very depressed aviation plan.

    Geraint Davies

  199. On that last point, Mr Everitt, am I right to say all of the prices went up just before NATS was sold off? I am right, am I not? The charges to airlines from NATS increased before the transaction occurred?
  200. (Mr Everitt) I have no idea. Not that I am aware of. I do not think so.

  201. Perhaps we can have a note on that to confirm that is the case. Can I ask Treasury, on the value of the sale we have been bandied round this figure of 800 million, am I right to say that in addition to that the government had to pay off some of the existing debts of NATS, 300 million?
  202. (Mr Glicksman) Some of that 800 million was used to pay off NATS.

  203. The net received was 500 million.
  204. (Mr Glicksman) Roughly that sort of figure after paying off the debt.

  205. On the assumption it was 800 million, the NAO suggest that as well.
  206. (Ms Lomax) The government's cash proceeds were 758 million, as stated in the NAO Report.

    (Mr Glicksman) Some of which was used to pay off the debt.

    (Ms Lomax) It is a clear answer, there is a very good table in the NATS ---

  207. Can we have a note on that as well?
  208. (Ms Lomax) There is no need for a note, if I may respectfully suggest, it is all set out very clearly in the NAO Report in Table 20, page 37.

  209. Perhaps the Treasury can advise how much debt was paid off?
  210. (Ms Lomax) 700 million of government debt was paid off, 330 was National Loan Fund debts, which was quite old.

    (Mr Glicksman) 330 million was paid off.

  211. We paid off a bit of our debt, then we got the funding. Moving on, if I may, may I ask, in terms of the way the competitive bid was managed, particularly in terms of the Airline Group Serco (Nimbus), given that the Airline Group fly planes and NATS were in the same market, and therefore subject to the same risk if there was a down turn due to Gulf War, or whatever it is was that factored in against the Nimbus bit, what I mean is, all things being equal, one would have thought one would go for the Nimbus and Serco to spread one's risk?
  212. (Ms Lomax) I am not sure how much risk spreading you would have got because Serco are also involved in this sector as well. If you are talking about a totally major impact to the aviation sector there was a provision in NATS' licence, as I think I mentioned a few minutes ago, for an exceptional price review.

  213. You mentioned that the world looks like a riskier place since September 11, if this deal were going through now, given we all know it is a riskier world we live in, how much less than 800 million would you think it was reasonable to take from the preferred bidder?
  214. (Ms Lomax) I cannot answer that question. I think that probably the structure of the deal would have been a little bit different. I think that the work that is going into the big announcement at the moment as a competent solution is a reflection of the need to adjust to the world as it is now.

  215. Can I ask something about delays. My understanding is that the level of delays prior to September 11 in Britain was similar in France, Germany and Spain but since September 11 they have reduced their delays because there has been less traffic and they are taking the opportunity to reduce delays, however our delays have increased. Why is that?
  216. (Mr Everitt) There are a number of reasons, I think. One is they have had the benefit of increased capacity through something called RVSM, which is vertical separation.

  217. Is it because they have a public sector remit and we have this narrow financial remit for NATS?
  218. (Mr Everitt) We have brought on this major centre at Swanwick which is a huge technical challenge. I have been on the record publicly saying we did not have enough controllers, we were some 30 to 40 controllers short, we have addressed that issue. In our memorandum you will see how we have progressed from the early summer.

  219. Is this a coincidence that after September 11 there is less traffic and in Britain we do a lot worse and it is nothing to do with PPP. Is that correct?
  220. (Mr Everitt) It is nothing to do with PPP, it is to do with the fact that we brought Swanwick on.

  221. You mentioned the issue of trained operators there, am I right in saying that given there is a lot of financial pressure on NATS it is true, is it not, that therefore you are shortening job training and assuming a higher level of pass rate for trained operators in order to hit your targets for the number of operators you have. Firstly, can you confirm that is true? Do you think there is a question mark over quality and, therefore, safety?
  222. (Mr Everitt) We have an independent regulator who will make sure we reach the right quality level. We have not shortened training. We have certainly set challenges to improve the pass rate, the pass rate is wholly unacceptable.

  223. You have not shortened job training? I understood from the Report that that was the case, from the NAO brief that members were given. Maybe we could have a note on that as a point of fact.
  224. (Mr Everitt) The training has to satisfy the CAA.

  225. 3.12, page 35 "shorten the period of on-the-job training". Four lines from the bottom, the period of on-the-job training has been shortened.
  226. (Mr Everitt) We, "hope to achieve significantly higher pass rates by more selective recruitment and effective training and shorten the period of on-the-job training". It is a hope. It is an aspiration. This is what happened in the airlines over many years.

  227. Will you be spending more or less on training?
  228. (Mr Everitt) We currently spend 23 to 25 million a year on training. I want to get more out of that money, like more people where I need them.

  229. May I ask, this is a tricky issue, on the Treasury rules that have been mentioned, there was this issue about where the public sector comparator is, obviously the public sector comparator presumably was the previous NATS, because we had something in operation. The question was, how do we get more money into the system for new investment, 1 billion as promised for PPP - we have not yet seen that - am I right to say if we had done that through a bond issue that that would not have counted towards PSVR according to the OECD definition in the Maastricht Treaty? If that is the case is it just Britain and the British Treasury who have perverse definitions that stop us putting bond money into the public sector?
  230. (Ms Lomax) You take me outside my field of expertise.

    (Mr Glicksman) I am not familiar with the Maastricht Treaty.

  231. You have not read the Maastricht Treaty! You must be conversant with the conventions on public sector borrowing requirements in our European partners, which happens to be the one in the Maastricht Treaty, which is that bond financing in this public service would not count. That is correct, is it not?
  232. (Mr Glicksman) I think we comply with the international conventions on the classification of expenditure.

  233. I am sure you do.
  234. (Mr Glicksman) I think the question is, what are the figures that are controlled rather than whether they are in the public sector or not?

  235. Is it not the case in terms of definitions and how we apply them that we have allowed a bit more flexibility in the terms of the Channel Tunnel rail link and United Kingdom regional airports?
  236. (Ms Lomax) We have in the case of the regional airports, that is correct, but not on anything like the scale that would be necessary for NATS purposes.

  237. May I ask, there are clearly difficult financial conditions, there is very high gearing, as has been made clear by Mr Williams, we also have a situation of massive technological uncertainty in the market by taking big risks on that, if it is necessary to offer greater financial assistance would we be asking the government for more money to put in if we had a situation akin to the West Coast Mainline Project? We do not know what the future holds, in the event that the market will not deliver the money I presume we will ask Treasury to bail out the system, is that right?
  238. (Mr Everitt) The first big tranche of capital investment, technically the most challenging one, has been Swanwick, which we bought in in January. Our objective is to renew most of the system over the next ten years. We think we can do that within the sort of figures that we have just been talking about. Part of our job as a management team is to manage that risk effectively.

  239. I know. If things end up costing more and the revenue is less than business assumptions and the private sector will not stump up the money what are you going to do, are you prepared for there to be some retrenchment of services or a question mark over some operational investment that underpins safety?
  240. (Mr Everitt) You are asking me to deal with a hypothetical. The responsibility that we have as a management team and as a board is to manage our way through these technically demanding projects, and they are technically demanding. The biggest one we have now brought home, which is Swanwick.

  241. Do you think there is a case for night time radar investment over Edinburgh Airport, there is not yet the traffic. Do you agree if there was a big constraint on finances that that sort of project that would improve safety would not be done. It may not be done anyway.
  242. (Mr Everitt) I would need to consider that. I do not know the circumstances about night time radar in Edinburgh.

    Mr Howarth

  243. Ms Lomax, one of the government's aims for the PPP was to improve management expertise in NATS and when you were answering the chairman's questions at the beginning of the session you made two pints which I thought were useful in terms of giving some indication of how these things were measured. The first one is that you said one of the aims was to achieve a stronger commercial framework. I think rather than one answer perhaps over a number of answers you have given some clues to that. The second one was to improve greater efficiency. It would be helpful before I go any further if you could define for me what you mean by stronger commercial framework and if could you define what you mean by efficiency in this particular context?
  244. (Ms Lomax) I was quoting when I used the words "stronger" and "commercial framework" from a memorandum Treasury sent to the Transport Select Committee in 1998 in explaining why we were going for the PPP rather than the not for profit. I am not sure it is necessarily a word that I would use myself. What do I mean by greater efficiency ---

  245. I did not ask you to tell me where you were quoting from I asked you what you thought it meant in this context?
  246. (Ms Lomax) I think it means an organisation which uses the resources at its disposal more effectively and more efficiently which perhaps some of the ways that Mr Everitt has been talking about this afternoon, it does not necessarily have the highest charges in Europe, for example.

  247. That does not explain the commercial part of it at the time, does it? The definition you have given could apply to any organisation.
  248. (Ms Lomax) Yes.

  249. What was distinctive about this particular one?
  250. (Ms Lomax) Commercial pressures come from the scrutiny of the strategic partner and the banks providing a demanding financial framework within which NATS' performance is assessed. For example the business plan is much more widely discussed now than it was in the public sector, people are scrutinising NATS' performance in a demanding sort of way and their ability to attract finance and maintain a good credit rating will depend on their performing. That, I think, is the sort of thing I had in mind when I was talking about strong commercial framework. Those sorts of disciplines come from seeking private finance in the financial market, it is very different from operating in a political competition for finance within the public sector.

  251. You went on to talk about greater efficiency, it seems an obvious question and sometimes the answer does not line up with the question, what did you mean by greater efficiency? How would you measure that?
  252. (Ms Lomax) There are a number of different ways of measuring efficiency. At the moment two thirds of the 5,800 people are not air traffic controllers.

    (Mr Everitt) We employ just under 2,000 people who are air traffic controllers, of which 1,400 are active, the others are in training.

    (Ms Lomax) No doubt eventually over a period of time the Airline Group certainly seem to envisage working towards an organisation which basically had more of the resorts put into the frontline operation. That would be one way which it might make them efficient.

  253. Any others?
  254. (Ms Lomax) I will ask Mr Everitt.

  255. I will be interested in what Mr Everitt has to say however it was you who used the phrases and I was trying to test out what you meant by them.
  256. (Ms Lomax) I was talking about the framework within which NATS was operating and the sort of scrutiny they were subjected to and the sorts of things that people would look at when they would decide whether NATS was performing well. They would certainly be looking at things like whether NATS brought on projects on time and into budget and got benefits from them. That is what investors were looking for and it is something which it has not been successful at in the past.

  257. Are you going to give greater clarity than that, Mr Everitt?
  258. (Mr Everitt) Commercially, as the Secretary of State said, the accountability, particularly to the capital markets for the money that we seek and, indeed, to our shareholders is one way. I think we are highly accountable for our performance now, not only to those capital markets but much more widely. We have independent regulators in a way we did not have before, we have economic regulators, we have safety regulators and stakeholder councils, so there is very high accountability. That is part of commercialism. I also think we now have an opportunity to take some of our skills and expertise outside the company and seek to learn from those. We are doing that in a measured way, because these are not easy markets to get into, but I would expect over time we will make good progress in that area too. Procurement is another area. We have spent a lot of time this year improving our procurement arrangements. We have also brought much greater efficiencies in the way that we transact our human resources, our facilities management, we bought all those into single organisations rather than having them scattered all over the business. There is a host of things we are striving to achieve to get greater efficiency, which means greater return for each pound we have available to us. That is really the way I would characterise it.

  259. I understand that you are in process of, you might have already introduced it, an executive bonus scheme?
  260. (Mr Everitt) Indeed.

  261. Can you tell me, against all of those criteria you have just suggested in relation to efficiency how each person's performance is measured against those?
  262. (Mr Everitt) Yes. We now have a bonus scheme for part of our senior management. They are rated in a number of areas, the overall safety performance of the business is number one, quite clearly. They have personal targets. We have financial targets in at least 3 of the 4 criteria that we use. Each year we assess their performance against their individual performance and obviously we assess where we are in relation to the overall group performance and then appropriate bonuses are determined. They will not be a single bonus for everybody or a single percentage for everybody, it will range according to how people perform.

  263. Is it possible that the organisation could be performing in financial terms badly but people could still be gaining additional rewards through the bonus scheme?
  264. (Mr Everitt) It would be right to say in the public sector that was a possibility. What we have done is introduced a bonus scheme which has an ability to pay element in it. One of the issues we face this year was that people had contractual entitlements to bonuses which was a carry over as the PPP came in, we changed that this year so that there is now an ability to pay element in the bonus.

  265. In other words if the organisation was performing badly it would follow that in some elements of that scheme nobody would qualify for it?
  266. (Mr Everitt) Yes. Part of the decision I had to make this year in relation to the contractual bonuses was how much we would be prepared to pay.

  267. Thank you. Can I come back to Ms Lomax, we left Mr Williams' line of questioning slightly unresolved and I ended up quite confused anyway. I think the point he was driving at, if I understood him correctly, was when you were determining the cost involved, whether or not viability was taken into account, the point he was making is - let me explain it, many, many years ago in my youth I was a member of the local authority and I remember that in the tendering procedure if you got an exceptionally low bid for a particular project it would have to be scrutinised very carefully just to make sure they were capable of delivering what they said in the price available. The concern we have about the difference between what was estimated as likely to be going through the transfer and what was bid was that maybe there was a problem of that kind that had not been taken into account. Have I made myself clear?
  268. (Ms Lomax) The test for financial credibility capacity was not properly executed, is that your point?

  269. It was not clear in the answers you gave earlier that was the case, no.
  270. (Ms Lomax) There was extensive testing of all of these bids against a range of financial criteria, yes, it was a long and very technical exercise and that was part of what the advisers were doing. I cannot now remember exactly what point Mr Williams was talking about. What I was trying to say in answer to somebody else was that the decision that was taken about which was the best bid took account of all of the evaluation criteria, it was not just the proceeds, it was not just the financial credibility capacity. it was a decision taken in the round.

    Chairman: Thank you, Mr Howarth.

    Mr Jenkins

  271. You paid some substantial costs to advisers and yet I noticed on page 24 you have the cost of implementing a partnership and the estimate for implementing the partnership and out turn quite at variant, who advises on the estimates?
  272. (Ms Lomax) I think that the original estimates were based on, it says in footnote one, the estimate was set in August 1999 using estimates provided by the advisers, NATS and the CAA.

  273. Who were the advisers, just NATS and the CAA?
  274. (Ms Lomax) The advisers estimated how much work they thought would be required. NATS and the CAA based its initial estimates on those views.

  275. I thought if the advisers were advising you with the estimate and it turned out in some cases they were substantially different, the legal advice went three times the out turn against the estimate, do you feel you had the right advice in place?
  276. (Ms Lomax) The original cost estimates were clearly optimistic. I think the Department took account of what information and advice was available not just from the advisers themselves but from NATS and the CAA and its own experience too of previous operations. What was clearly the case is this was a much lengthier process and a more complex process than people understood when those original estimates were met.

  277. One of the things which Mr Williams started off with, I am still struggling here, I must be honest, if I read it correctly, I obviously do not, because I do not understand these systems, we sold half a company in effect which was worth quite a substantial amount of money and when we sold the company the purchaser put a very small amount of funding into that and then borrowed the rest from the bank. The debt was not on them but the debt becomes that of the company. I own half the company, so I presume it must be my debt as well then?
  278. (Ms Lomax) I do not think this is a completely unconventional way of making an acquisition. I think this happens quite commonly and you always put debt on acquired company, you put as much debt on you think it can bear given the amount of income it is likely to generate. The more debt you put into it the less there is going to bed available for splitting out between the equity shareholders. The general view for regulated utilities I think is that making large profits for the equity shareholder is not a good thing.

  279. I have the debt of the company that I once owned and I got half the money in the bank, so now I have 49 per cent of the company, this cannot be right, nobody would buy this one, so all of the profit in future years, and I use that term advisedly, is going to go to the bank, obviously. I am going to sit back and watch that debt be financed over the next number of years without any income coming to me. Am I right?
  280. (Mr Everitt) That I think is correct. In other words the bank have the first call on the money in the business to service that debt. It was a very clear policy of the Airline Group that we would use the remainder to contribute to the capital expenditure of the business. It would certainly be the case in the initial years.

  281. At the end of the day I am the 49 per cent owner of this company and what would be profit to me is not going to come to me because it is going to be paid to pay off the debt of my partner who borrowed the money, so I am going to pay for it, am I not?
  282. (Ms Lomax) You managed to get 758 million in proceeds to compensate you in the beginning.

  283. You sold it for 700 million.
  284. (Ms Lomax) The value of NATS at the time, at the risk of confusing this any more, the total value of the business at the time of the sale was estimated to be rather higher than 758 million, something like 873 million, the difference between the 758 and the 873 being the value of the equity is the way I have looked at it.

  285. In effect the business had gone.
  286. (Ms Lomax) No.

  287. There would never be a return from this business, anybody who thinks so would be in cloud cuckoo land.
  288. (Ms Lomax) I do not think anybody thought NATS as a profit generator, it was supposed to be a better deal for NATS as a business. All of the debate about it and the structure of the PPPs is about providing a better framework for which NATS can provide air traffic control services not as a profit generator for the government or the Airline Group.

  289. I thought I had seen something in one of the charts, one of the criteria used to depict this scheme, page 15, was providing a return to the taxpayer, you know that poor sucker out there.
  290. (Ms Lomax) Yes.

  291. Proceeds from 46 per cent of the sale and future dividends. Somebody must have thought there was future dividends somewhere.
  292. (Ms Lomax) The legislation does allow the PPP to pay dividends, it is just that the Airline Group put in its bid on the basis that it would not be looking for future dividends.

  293. Of course it will not be looking at future dividends, that is the main benefitor from the fact we can keep the price down low, we are not transferring money from them into dividends and half of which will go back to the taxpayer. You would not have that deal?
  294. (Ms Lomax) I am not sure I follow you.

  295. If you have a company running and it makes a small amount of profit, 49 per cent goes back to the 49 per cent tax holder and 49 per cent goes back to the Airline Group, now the only place that profit can be generated is in the charges to the airline companies. Am I right? If they make a profit on the airline companies, 49 per cent of which is going to go back to the partner, they are going to be at a disadvantage and what they want to do it take up that profit totally, no profit, and therefore 49 per cent will not go back to the partner, but the costs on them as the consumers will be less. Am I right?
  296. (Ms Lomax) I think the impact on them as consumers - I am not sure I am entirely with you - the body will determine the charges to consumers, to airlines, to the CAA through its economic regulation division. It is the economic regulator that sets the prices. I do not think the Airline Group has the ability to manipulate a business in NATS to its own advantage. There are various safeguards in the structure of the PPP to make sure that NATS is not run for the benefit of the Airline Group in the way that you seem to be implying.

    (Mr Everitt) I also think it is critical we make profits in order to invest. We have to make profits in order to invest because that is the only way we are going to attract the income.

  297. That is just money going back in, reinvestment in the company.
  298. (Mr Everitt) Surplus being reinvested.

  299. The bank get their surplus, the management get a bonus because they are now creating surpluses, what does the taxpayer get?
  300. (Mr Everitt) When dividends are ultimately paid they will get 49 per cent of the dividends.

  301. Would you like to estimate what year that would be, please?
  302. (Mr Everitt) What has gone on here economically is that the taxpayer has taken a very sizable sum, in other words in lieu of certainly dividends over the next few years. That is really what has gone on here.

  303. When you go to the bank for any working capital, like you did last year, you turn up to the government, you went to the government because the bank said they would give you no more.
  304. (Mr Everitt) We were in a period where we had not settled with the Civil Aviation Authority and the Civil Aviation Authority were considering our application for price adjustments. This was a temporary facility, hence it ran out in September, to tied us over a period to enable the CAA to make a decision. It has taken longer to get the CAA decision but we have not had to call on that money. It is not a precedent for the future.

  305. You are being sent notes that are quicker than your answers at the moment. When you look at any company, and if you look at this one in particular, you realise because of the viable nature of it as an entity you can load some debt on to a company but at one point the bank say "no more". How close would you be to that point where the bank say no more? How much debt would you have to have before this company becomes non-viable and you will you have to move to put it into administration? Have you worked out a scenario? Have you got an exit route mapped out?
  306. (Ms Lomax) The CAA has made it clear that it thinks that an appropriate financial structure for NATS in the current circumstances given the risks as we now see them post September 11 is less debt than it had at the time the PPP was concluded. That is part of what the financial restructuring is achieving. Both the government and the new shareholder will put in some more equity to reduce the amount of bank borrowing levels. That is the essence of the composite agreement that is being discussed at the moment. The details on it are not finalised but at the moment but that is where we are.

  307. Do not tell me that our partners are going to borrow this money off the banks and incur a further debt on the company, they are going to put in cash, are they?
  308. (Ms Lomax) This is a conversation that is going on between NATS and the CAA, I do not want to anticipate a deal which has not yet been done.

    Chairman: You are going to have to leave it there.

    Mr Davidson

  309. Can I ask Mr Everitt, if I heard you correctly you mentioned that the airlines were going to have a 12 per cent reduction in charges.
  310. (Mr Everitt) The average increase in Europe this calender year was 12 per cent, that took effect last April. We went down 1.5 per cent.

  311. That is a 13.5 per cent difference had we been following. I am not clear in terms of the scale of this how much you receive in income overall from airlines?
  312. (Mr Everitt) Our total income is just under 500 million a year from airlines in the en route business and another 80 or so in the airports business.

  313. Leaving aside 13.5 per cent, that is too complicated. If I took 10 per cent of that it is 50 million that airlines would have saved by your charges not having gone up, considering a consortium of airlines paid round about 50 million for a share in yourselves they have effectively got most of the money back in 15 months or so?
  314. (Mr Everitt) They are about 25 per cent of our costs. They pay about 25 per cent of our charges.

  315. The reduced charges they are paying is in effect a shareholder dividend for them and they have got a substantial percentage of their money back already.
  316. (Mr Everitt) I think there are very few airlines that would see it quite that way. They have clearly lost significant sums of money in the past 12 months, certainly the major carriers have obviously tremendous difficulties.

  317. In terms of those that put in the 50 odd million to yourselves they have had a substantial proportion of that back already in reduced charges?
  318. (Mr Everitt) I think it is difficult to characterise it in that way because whether they invested in us or not they would still ---

  319. That is how I see it, I must say. Ms Lomax, if we are having this restructuring which is going to have a reduction of the percentage of debt and an increase in the percentage of capital, presumably that will mean the government putting back in some of the money it got out from the sale?
  320. (Ms Lomax) We have already made it clear, and it is in the NAO Report, that the government will match as a responsible shareholder contribution by another equity shareholder, yes.

  321. That is a yes to the question I asked?
  322. (Ms Lomax) We will not go beyond that.

  323. Can I turn to Mr Everitt then, as I understood it you said earlier on for the last 15 months capital investment had been funded by the cashflow of the business itself. In those circumstances I find if difficult to see where the gain has come from this partial privatisation since presumably if you are capable of financing your investment by your cashflow, because the bank are refusing to give you any more money, you could have done it without this creation of debt and all of the rest of it? If you did not have the interest on the debt you would have a greater cashflow free for investment. Does that seem a fair way of looking at it?
  324. (Mr Everitt) That is a way of looking at it. The way I have looked at it is that we have needed to conserve cash in the business. As I set out earlier, my criteria were that safety was paramount, et cetera. What we will need is access to additional capital as we move into more significant projects.

  325. As of now you are funding your capital investment from cashflow and therefore the whole process of privatisation has made not one jot to your ability up to now to reinvest because it does not seem to have made any difference. Indeed it has made your position worse since you had not had this high interest capital debt on your backs then you would have had more free cashflow in order to plough into your investment?
  326. (Mr Everitt) I have had to deal with the situation that I have had, that was clearly that we do have the debt in the business. What privatisation has brought to it is a number of things we outlined, not least charges to the customer going down in very difficult circumstances.

  327. I may become back to that if I have time in a moment. I take it that the cost of borrowing from government would have been less than the cost of the borrowings that the Airline Group undertook. This is to Mr Everitt, can you give us an indication of by how much more the debt was costing and is costing in interest terms?
  328. (Ms Lomax) In general terms government can usually borrow significantly cheaper than anybody else. I do not know what the expect margin will be.

    (Mr Glicksman) It varies.

  329. In terms of looking at what the government got back in terms of 750 odd million, one per cent difference of that would have been in terms of interest payments, how much are we talking about as a saving?
  330. (Mr Everitt) About half a million.

  331. 50 million this year!.
  332. (Ms Lomax) Half a million.

  333. Half a million.
  334. (Mr Everitt) A bit more, 7 million.

  335. It has been suggested to me in terms of the cost of management comparing like with like in terms of the position now and the position before the cost of the upper range of management has gone up by 70 per cent since the PPP was introduced. Can you confirm that is correct?
  336. (Mr Everitt) I do not have that number at my fingertips. I am looking at our Annual Report. There has certainly been some increase but I cannot confirm that number.

  337. Round about 70 per cent?
  338. (Mr Everitt) I do not know, I would have to check that.

  339. I find it surprising that you do not have it at your fingertips, an indication of how much the management cost has gone up. If it is 70 per cent that is a surprising figure, after all we are not talking firemen here. I would have thought that we had some explanation of that. Can I ask about the cost of advisers and whether or not Ms Lomax in the circumstances did you think that the cost of advisers was actually good value for money. I did come across a table in here on page 24 where the costs of advisers for this privatisation is greater than the cost of advisers for the privatisation of the rolling stock companies, rail freight distribution, Scottish Plastic, HMSO, LT Bus Companies, Royal Ordinance and National Transcom put together. In these circumstances do you not think you were taken for a bit of a ride by the way in which you struck the deal with your advisers, whereby they were being paid irrespective of whether they did any work.
  340. (Ms Lomax) That is the way these people are customarily remunerated. I think a large, highly complex, highly controversial deal like this is not one to buy advice on. You want the best advice you possibly can when you are dealing with such a large, sensitive and important business.

  341. Given size and given the percentage of the pay compared to the cost of the advisers it is a much, much higher percentage than in almost any other privatisation. Is this just so much more complex than any other privatisation to justify these fees?
  342. (Ms Lomax) I quote back to you what the NAO says, as each deal is different any comparisons have to be treated with care. As a proportion of the value of the assets sold the transaction costs are higher than average but not evidently unreasonably so given the need in this case to negotiate an on-going PPP as opposed to a more straight forward trade sell.

  343. I find it very interesting that at the beginning you mentioned there was no public sector comparator for this privatisation, were you aware that members of Parliament were told this was not a privatisation?
  344. (Ms Lomax) I did not say it was a privatisation. I said in privatisation there was not one.

  345. Why did you make that comparison?
  346. (Ms Lomax) It was a partial share sale.

  347. What is that, a partial privatisation?
  348. (Ms Lomax) Yes, it is a partial privatisation, is it not, but of a particular and innovative kind which safeguards the concerns that members on both sides expressed very strongly.

  349. Can you clarify why the Department while this process was being undertaken was telling members of parliament it was not a privatisation?
  350. (Ms Lomax) It is not a simple privatisation, it is a public private partnership.

  351. It is not privatisation then?
  352. (Ms Lomax) It is not the same as a privatisation, no. The idea of a public sector comparator is of relevance. I suggest in situations where there is not a policy decision to do it as there was in privatisation, this reflected a policy decision to sell off some of the shares in NATS, to sell equity interest and to seek a strategic partner for NATS, it went through the House of Commons and it was extensively debated. It is not something that was a sort of value-for-money decision by a civil servant.

  353. I think my point has been made.
  354. Chairman

  355. We are going to have to read the transcript, I thought you said in answer to questioning from Alan Williams you were saying something along the lines of we do not have public sector comparisons in privatisation.
  356. (Ms Lomax) Would it be helpful if I clarified what I tried to say because one does not always say absolutely what one means the first time round, I was trying to say that public sector comparators are not the invariable rule, we do them for PFI projects but we not do them for privatisation, where there is this much greater degree of political involvement, including in the House of Commons. With a PFI deal it would not go through the House of Commons, it would not be such a political thing, it would be a value-for-money decision. I as accounting officer would need to satisfy myself this was good value for money. This was much more in the political arena of policy decision.

  357. Was that yes or no?
  358. (Ms Lomax) I do not know what the question was.

    Chairman

  359. We will have to leave it there.
  360. (Ms Lomax) I would like to clarify at the end the confusion I caused over Figure 21.

  361. We will come back to that.
  362. (Mr Everitt) Can I just mention that the cost of the board has gone up from 684,000 to 770,000 from 2001/2002, I calculate that as 12.5 per cent. At that time we had taken on 3 government directors as well. I think there were reasons for it.

  363. Can I clarify whether or not that is a like for like comparison in terms of senior management?
  364. (Mr Everitt) I am simply taking the costs in our accounts of the board remuneration to directors in total, non-executive as well as executive, for 2001/2002.

    Chairman: That is not an answer to the point. I wonder if we can have a note clarifying what the comparison like to like for senior management is. It is my understanding it is a 70 per cent increase. If that is not the case I would be grateful to have that clarified.

    Mr Bacon

  365. I have a copy of the report accounts and the page concerning the directors salaries, it is not particularly clear so if you can give us a note setting out all of remuneration for non-executives and executives for the period prior and after the part privatisation that would be very helpful. It appears there were 3 executive directors getting round 230,000. Tell me, given that your controllers had to go on strike to get their pay rise, asking government for more money, do you think the pay rise and bonuses were excessive?
  366. (Mr Everitt) My personal pay was settled at the time I joined the company.

  367. I was not just talking about you, I was talking about everybody.
  368. (Mr Everitt) So far as the second director is concerned, that contains an exceptional bonus which was paid and agreed prior to PPP and which triggered on the opening of Swanwick.

  369. This was the 69,000 to Mr Chiswick?
  370. (Mr Everitt) Part of the 69,000 was his general bonus and the second part, the 39,000, related to Swanwick.

  371. Given what has happened, do you think these payments were excessive?
  372. (Mr Everitt) The payment was contractual.

  373. I did not ask about its legal status. I asked whether you thought this was excessive.
  374. (Mr Everitt) It was certainly justified against the fact that he took hold of this project three years before.

  375. If you could put it in the note. I certainly would have expected it to be legal. I was asking what your personal opinion was of them. If you could let us have a note on that, that would be very helpful. What is your current situation so far as shortage of controllers is concerned? How many are you short now?
  376. (Mr Everitt) In Swanwick we are now in the winter season so we would not normally open as many sectors as we would in the summer. Our plans are focused on next summer and a considerable amount of work is going into the planning for next summer. On our current estimates we would think that we could be up to 12 controllers short for next summer, but we are working on that and our plan is not settled.

  377. My question is about now, what are you at now?
  378. (Mr Everitt) From the summer we were 40 short.

  379. Could you say that again?
  380. (Mr Everitt) Between 30 and 40 short this summer.

  381. And right now?
  382. (Mr Everitt) I do not have the precise number as of this moment.

  383. Could you send us a note showing how it has changed in the past and what you are anticipating in the future?
  384. (Mr Everitt) Sure.

  385. How many days have you bought back?
  386. (Mr Everitt) You mean in terms of the deal that we did we controllers for voluntary attendance?

  387. Yes, how many days?
  388. (Mr Everitt) I could give you a note on that. Very few so far, they would mainly be for summer next year.

  389. How many days off are controllers owed?
  390. (Mr Everitt) As part of the pay deal we are buying out their days off.

  391. I was not asking you that, with respect.
  392. (Mr Everitt) I have not got the number at my fingertips.

  393. I would like to know how many days off controllers are owed. If you cannot answer the question now could you not answer a different question I did not ask but just save us time and send us a note. I do not have a lot of time and it is just annoying when I get an answer that is not an answer to the question I asked. Could you say what has been the increase in overload reports?
  394. (Mr Everitt) I can give you a precise number on that but, again, I would want to give you a note. There has certainly been an increase but that has apparently been a consequence of Swanwick coming into operation.

  395. Are you familiar with the form that controllers fill in when they have a report?
  396. (Mr Everitt) Yes, a 1261.

  397. Is it correct that the form has been changed so that it no longer has to be countersigned by the watch manager and supervisor?
  398. (Mr Everitt) That I do not know, I would have to check.

  399. Again if you could let us have a note. I understand it did used to have a section underneath where the watch manager or supervisor had to agree or not agree with the comment logged by the controller. I am told this section has now been removed and I would like to know if that is the case or not.
  400. (Mr Everitt) I would have to check.

  401. Your approval under Article 88 of the Navigation Orders; is it permanent or temporary?
  402. (Mr Everitt) I think it is an indefinite approval.

  403. You think it is?
  404. (Mr Everitt) Yes.

  405. What about when it was first given in January, was it permanent or temporary?
  406. (Mr Everitt) Indeed it was --- I will need to check that but my understanding ---

  407. There is a letter to you from Mr Dancer, the head of Air Traffic Safety Standards Department from 22 January in which he tells you that your Article 88 Air Navigation Order approval has again been time-limited. It cannot be indefinite and time-limited at the same time, can it?
  408. (Mr Everitt) I would need to check that.

  409. Which is it now? Indefinite?
  410. (Mr Everitt) My understanding is that it is indefinite but I would need to check.

    Chairman

  411. You seem to have to check a lot of things. You run this thing.
  412. (Mr Everitt) I did not come prepared for operational questions, I thought we were talking about the NAO Report.

    Mr Bacon

  413. I am curious because the Health and Safety Executive on 18 January, four days before you opened, said there were concerns about safety in relation to the centre and what it called "design deficiencies" which may have implications in relation to air safety and that as a result of that, presumably, that was why you were given a time-limited approval?
  414. (Mr Everitt) No.

  415. That is not the case?
  416. (Mr Everitt) I do not think that is the case at all. We were given checks before we opened Swanwick and the safety regulator was perfectly content that Swanwick met all aviation safety requirements and the health and safety issues were around the possible effects on people at work, as it were; they were not air safety issues.

  417. Is it a matter of the regulator's opinion or is it a question of what the law says?
  418. (Mr Everitt) The aviation safety regulator clearly has to make judgments, as most regulators would have to in these circumstances, and those were the CAA's judgments.

  419. What I want to know is if your contempt was okay, why did your approval say, and I have got a copy of it here: "This approval is effective from 26 January 2002 to 26 July 2002, unless revoked, varied or suspended", and why was it given this time-limited condition?
  420. (Mr Everitt) Can I just check for one moment. Could I give you a note on that rather than speculate.

  421. You have been telling me in your first answers that the approval was indefinite.
  422. (Mr Everitt) That is my understanding.

  423. This is a fairly fundamental thing, whether you can operate or not. It says here: "Air Navigation Order Article 88, approval for the provision of air traffic services." That is what you do, is it not?
  424. (Mr Everitt) Indeed.

  425. So this is the right piece of paper I have got. You have approval here subject to the conditions stated in the schedule and it has got a date on it and it says effective to 26 July. In your first answer to me on this subject you were saying it is indefinite. It plainly is not indefinite, is it?
  426. (Mr Everitt) My understanding relates to the current approval we have. We have approval to operate an air traffic service as issued by the regulator.

  427. I hope you do. My question was whether it is a permanent approval.
  428. (Mr Everitt) Could I give you a note on that.

  429. Yes please, fine. I want to ask you about height capping. I understand this is a standard procedure in the industry. How much has height capping increased since Swanwick opened?
  430. (Mr Everitt) I can give you a percentage but obviously, as we have boarded in and dealt with the situation this summer, there has been an increase in height capping, yes, and that has been part of the management of the system as we have worked through the opening of Swanwick.

  431. Could you give me a note - and perhaps you can answer it now and if you can that would be great - on how many journeys there have been which have been height capped since Swanwick opened?
  432. (Mr Everitt) I think that would be difficult but I will do my best.

  433. And also over the last three years at West Drayton prior to Swanwick opening how many journeys were height capped?
  434. (Mr Everitt) I will do the best I can but we obviously do not measure each one.

    Mr Bacon: No further questions.

    Chairman

  435. Could you give us a note on the interest paid on each of the years since the start of PPP?
  436. (Mr Everitt) Certainly, very easily.

  437. This retainer paid to CSFB; was it good value to pay them a monthly retainer irrespective of the work that they did?
  438. (Ms Lomax) We think so, yes. They did a lot of work

  439. But was it good idea to pay them a monthly retainer irrespective of the amount of work that they did?
  440. (Ms Lomax) That is the way they are normally renumerated by their clients and they are not alone; most similar firms operate on exactly the same basis. Lawyers do not and that is why we dealt with Slaughter & May differently.

  441. Let's not get involved with lawyers. Is it fair to regard NATS as a utility like water. Surely it is inherently riskier and therefore unsuitable for RPI-X or minus regulation? It is inherently riskier, is it not?
  442. (Ms Lomax) It looks that way. How risky it is depends on how the regulator himself behaves. I think it is difficult to say how risky a utility is in the absence of clearly stated regulatory policy and that is only now being agreed.

  443. Let us get back to this question of paragraph 3.27. If you turn to that on page 39 it deals with figure 21 on which there was debate earlier. You will see at the end of paragraph 3.27 it says, "given a reduction in traffic on the scale experienced in both of the oil shocks, each of which lasted several years, we found that NATS would have been unable to reach its debt service obligations." It shows, does it not, that a down turn as bad as either of the oil shocks would have left NATS unable to meet its debt service commitment? It does show that, does it not? Paragraph 3.27 says that.
  444. (Ms Lomax) We have not seen that.

  445. It does say that. Did your Department realise this and decide to ignore it or did your Department fail to realise that NATS' finances would not be robust? Which of those two did you do? Did you ignore the information that was given to you or did you realise NATS' finances would not be robust? Did your Department realise this?
  446. (Ms Lomax) Can I approach the question from a different end and explain why I succeeded in confusing everybody, because I did not mean to quarrel with the NAO Report and I got led into it by simply assuming that the figures in Table 21 were the same as the figures in Table 24, or whatever it was, which was flights. The confusion arises because it is a fact that chargeable service units are not available on a consistent basis before 1983. I want to get into why I confused you, I will come to it in the end. The material that you have got in Table 41, chargeable service units -

  447. Do not go too quickly.
  448. (Ms Lomax) -- where we got into confusion is the table which shows different scenarios. What the NAO says is, look at these scenarios, they did not test them and when we tested them they showed that the bid was financially flawed. When I said that, while we might not have tested exactly these, enormously extensive stress testing was done which showed that the bid was robust. We got into great confusion and you said, did you or did you not do these and I said these are on a different basis. Let me go back, this Table 21 I had assumed was flights because everything else is in terms of flights. The reason I assumed that it was flights is because I know that before 1983 chargeable service units are not available on the same basis as post 1983. What has happened, I have now had advice from behind me, is that NAO extrapolated these figures from flight data and basically recreated a series for chargeable sales units before 1983. This was a subject for some unhappiness while the Report was being prepared. Why I should not have mentioned it is we basically decided not to push it.

  449. Jeremy, will you help me on this, will you try and explain to the Committee what is going on?
  450. (Mr Colman) I agree with every word Ms Lomax has just said. There was discussion, the scenarios in grey in Figure 21 are scenarios that we constructed extrapolating from data regarding flights. Our point is that these were scenarios that were markedly worse than those that are in blue and however they are measured we asked the Department whether they had tested the robustness of the model against those scenarios. We did our own modelling, which is what 3.27 is about, which suggests that either of the oil shocks, were they to have been repeated with the NATS' financial structure in place, would have caused difficulties. 3.27 is reporting NAO's analysis.

    (Ms Lomax) Not shared with the Department or CSFB. My answer is what you say is interesting and I fully accept that we did not challenge this, and I must say I walked into this debate by mistake. The point I was trying to make is it is a highly technical business testing these bids, they were tested extensively against a wide range of scenarios, volumes and volumes of scenarios were tested.

    Mr Davidson

  451. Surely that is what your advisers got 40 million for?
  452. (Ms Lomax) That is exactly what they were for and that is what they were doing to earn this huge amount of money. They did not specifically test a repeat of 1973 and 1979, but they did test ---

    Chairman

  453. Why did they not do that, after all we had had 1973 and 1979?
  454. (Ms Lomax) Why did they not? I have had two answers to this. They did test scenarios which they regarded as severe but more relevant, a sustained period of low growth for 10 years and a sudden shock to CSUs in the scale of the Gulf War. In both cases the Airline Group bid was robust, NATS did not go out of money. They also asked themselves a different question, which is not discussed here, how severe a shock would there have to be to cause this real trouble to this financial model? The answer they got was one which was regarded as so extreme as not to be worth pursuing. The real issues that I was trying to explain is the problem is that peoples' imagination of the situation in May did not embrace a situation as severe as actually happened. You can do an awful lot of arithmetic if you like but if you think the world is a safer place than it was -- it is complicated, but very, very many scenarios were tested. The point that is being made, the general point that the NAO is making, which I am taking issue with, is that the Department did not do due diligence on these bids. I am challenging that. The Department took good advice and did extensive testing of all of the bids which people at the time thought was relevant. Did they do enough? In the light of what has happened they did not. Basically the world turned out to be altogether capable of more savage down turns than we had realised before.

  455. That is not the point. We are not on the point of more savage down turns. I must come back to the NAO here, what you are telling us, the NAO, is that if there had been a study done on what might happen on the same scale as the oil shocks this deal would not have been robust?
  456. (Mr Colman) That is what our modelling suggested. Paragraph 3.28 shows the results of our discussion with the Department's advisers CSFB. Their view was that it would be inefficient to leave capital lying round in NATS, as it were, waiting for such a shock. It is clearly possible to have a debate about whether that is sound or not. The consequence is if you do not leave the capital in and shock occurs you have to do something about it.

    (Ms Lomax) Can I suggest that is a different point, that it is not worth looking at these down side shocks, there are other mechanisms to cope with them and therefore we should not put in reserves or whatever you are suggesting in your recommendations. If you did the modelling we have not seen it.

    Mr Williams

  457. That makes it worse because they did not take into account the basic point which has been asked on several occasions, that anything that affected or created a down turn for NATS would create a down turn for the shareholders, for the 7 air companies and therefore it was incompetent to give the advice they gave but it was better for the shareholders to respond to the company's needs as risk transpired because the sort of risk we are talking about would affect them all equally or approximately equally.
  458. (Ms Lomax) That is another point and I would like to respond to it, we established a regulatory system which can respond to exceptional events. There is a clause in the NATS' licence which specifically permits an exceptional user contribution if something happens which impairs the ability of both the shareholders and NATS to respond in the way that you are worrying about. We did think about that particular scenario. That is why it has got that clause in the licence. Also at the moment the PPP is coping with such a situation without falling apart. The CAA is negotiating with NATS on a composite solution where the burden will be shared between users, shareholders, investors and the company.

    (Mr Everitt) And the company.

    (Ms Lomax) And the company. The company is having to make adjustments which if it had remained in the public sector it would not have had to make.

  459. Surely that leaves all the risk with one shareholder, the Government?
  460. (Ms Lomax) No, it does not.

  461. Who else could carry the risk?
  462. (Ms Lomax) The risk is being spread between users through user charges. In all other air traffic control bodies the risk has been passed straight on to users in the form of higher charges. Most of the other air traffic control bodies put up their charges by amounts ranging from six, ten or even more per cent. NAVCANADA put theirs up by ten per cent. It is in the annex to this Report. That is one way in which the risk can be carried. Banks are having to participate in a refinancing of the loan and we are finding another equity shareholder in the Government responsible shareholder who has agreed to put in some money to match. It is not just simply coming back to the Government.

    Chairman: Obviously, as my colleague says, we will want to be kept informed on how this develops.

    Geraint Davies

  463. Just one final clarification on these three grey columns. It seems to me that what these three grey columns show is that every ten years there has been a scenario in which the NATS model does not stand up to this sort of shock. The next ten-year shock happened to be 11 September but history shows us that it was not just one event, it was three events in 30 years. It seems remarkable therefore that those three scenarios which occurred, as opposed to a hypothetical scenario we could never have managed, were not factored into what we were proposing and in fact they would not stand up to financial scrutiny.
  464. (Ms Lomax) Can I make one observation which is that the four separate committees of the banks who were putting in a very large amount of money into this bid, and who want to be repaid, looked independently at downside scenarios and stress tested these bids. It is not just something that was down to our advisers in the Department.

  465. So none of them asked the question what would happen if the 1979 or the1983 with the Gulf War oil shocks occurred -
  466. (Ms Lomax) The conclusion that was drawn was that the bids were robust against foreseeable shocks at that stage. As I say, what was ---

  467. You do not agree that history is the foreseeable future?
  468. (Ms Lomax) If you go back you could say, "Why do you not replay the Second World War?" What is relevant is what people think will happen in the world in which we live at the moment, and people's views on that change.

    Mr Williams

  469. This was foreseeing for 20 years ahead, not a year or two ahead, so how can you justify not taking into account the fact that we are in one of the most volatile areas in the world where the aircraft industry is very vulnerable, but we completely ignore the experience of the previous 20 years, because when you were doing this the 1979 shock was within the 20-year period.
  470. (Ms Lomax) I do not want to argue that in the world as it has now developed that enough downside testing was done. The thing that I am trying to throw doubt on is the idea that there was a perfectly obvious piece of downside scenario testing which should have been done which we utterly failed to do. I do not think that is a fair description of what went on. I think there was a very conscientious attempt to test these bids against the very wide range of scenarios and they did not predict 11 September.

    Geraint Davies

  471. It is the case that OPEC still exists and Saddam Hussain still exists, so the causes of those three shocks are still there, are they not?
  472. (Mr Everitt) Can I make a point here. There is a very important condition in our licence that if we experience exceptional circumstances as they are defined - and I think by any standards the oil shocks of the 1970s and 1980s (and I was certainly in the industry when that was experienced) would be exceptional - the regulator can step in. This is not an unusual provision. You will find something similar, I am sure, in other regulated environments. The difference compared with NAVCANADA is that NAVCANADA have control over what their price levels will be. You have heard they went up six per cent last January and they are going up three per cent this January. Here we have a regulator who arbitrates, in effect, between the company and the users, and I think the design of condition 25, the exceptional circumstances condition, was to try and make some provision for circumstances of the type that could not be envisaged that we might experience and that is, in effect, although we are going under a different provision in the Transport Act, precisely what we are doing now. We are working through with all parties to this composite solution to deal with the totally unexpected and I think unforeseeable event.

    Mr Davidson

  473. One question for the National Audit Office, if I could, just for clarification. One of the issues that perplexed a lot of us during these debates was the question of NAVCANADA and whether or not its structure would be classified as in the public sector and therefore count against the borrowing requirement. Can you clarify for us whether or not in your understanding the UK Government were using the same criteria to judge what was going to be in the public sector borrowing requirement as a) Canada and b) equivalent European countries? If that is too hard without notice, I wonder if it would be possible to have a note on that, Chairman, because that was one of the main issues at the time as to whether or not a not for profit solution possible and the argument was that the British Government were using different rules. We have now heard it was all the fault of the Office of National Statistics which akin somewhat to saying "a bad boy did it and ran away" from the Treasury. I am not sure I entirely accept that analysis.
  474. (Mr Colman) I would take the opportunity of putting in a note on that, if I may.

    Mr Rendel

  475. I want to go back, I am afraid, to this whole question of the scenarios. I wanted to get one thing straight before I start. Paragraph 3.23 makes it clear that there were nine mandatory scenarios which were tested at the request of the Department. Both Nimbus and the Airline Group had to test those nine mandatory scenarios and only one of those dealt with adverse variations in traffic. So for some reason the Department decided not to ask for the sort of variations in traffic that happened, for example, during the oil crises because the only variation in traffic that was required was the current rise of 6.7 per cent which reduced to the 6.5 per cent scenario. There was still going to be a big increase in traffic but not as big as happened before so the Department did not require any scenarios with, for example, zero increase in traffic over three or four years?
  476. (Ms Lomax) No, it did not.

  477. Secondly, the groups were asked in para 3.24 to show any further scenarios which had been requested, presumably by themselves or by their lender banks, so when you mentioned the lender banks all the testing that was required by the lender banks is included in these blue columns under figure 21, so we can see there everything that the bank has asked for. In paragraph 3.24 the Department requested sight of any further sensitivity testing which had been run on the bidders financial models.
  478. (Ms Lomax) Those were what the airlines asked for.

  479. All the banks and the Airline Group.
  480. (Ms Lomax) Those are the ones the banks and Airlines group asked for.

  481. Are you saying you also ran certain scenarios, not the mandatory ones the airlines were asked to run nor the ones that they chose to run, but some other scenarios which were run by CSFB as well, quite separate from these?
  482. (Ms Lomax) Yes, and I gather that every scenario done by the other bidders, Nimbus for example, was also run by the Airline Group, so there was very extensive stress testing using all the scenarios anyone could think of.

  483. And neither those that were requested mandatorily nor the ones the airline groups admitted to having done nor presumably the ones Nimbus had done included a period of two or three or four years at the beginning of the period under consideration when there was no increase in traffic?
  484. (Ms Lomax) Two traffic scenarios were undertaken, one was a sustained period of low growth roundabout 3.5 per cent in CSU users, the other was a sudden shock to CSUs in the scale of the Gulf War.

  485. Is that the one that is said to be lower traffic in year 6?
  486. (Ms Lomax) The reason why it is in year 6 is because year 6 is the most difficult year, the year where it is most likely to fail. That is the one I am talking about.

  487. That is the Gulf War.
  488. (Ms Lomax) It was chosen because it was the most difficult year.

  489. You did not do anything like the two oil shocks and nobody did anything like the two oil shocks. Did CSFB do something about the two oil shocks?
  490. (Ms Lomax) They did tests which they thought were comparable in severity.

  491. To the two oil shocks.
  492. (Ms Lomax) The scenarios were based on looking at experience since 1983. I do not think anybody did -

  493. They did not.
  494. (Ms Lomax) Nobody modelled the two oil shocks as such, the comparable data was not available.

    Mr Rendel: Nobody but nobody in all of these people who are doing the testing, whether it is CSFB, the mandatory testing, the bank or whether it is the Airline Group, nobody but nobody modelled the oil shocks. Personally I find that quite extraordinary. You did go on to say that the advisers were then asked to see what scenario would make the finances non-viable. You went on to say that they found that the only scenario that would make finances not viable were so extreme that it was not to be credible. The oil shock scenario made the finances non-viable, we are told that, because it was modelled eventually by the NAO. We are told that in paragraph 3.27. Why did the advisers not discover that an oil shocks scenario - which could not be described as non-credible because it happened twice - would make the finances non-viable. The advisers seem to have let you down very badly.

    Chairman

  495. We have made our point. Do you want to have one last stab at it?
  496. (Ms Lomax) What I can do is send you a detailed note on what the stress testing was and our comments on the points that have been made. I think I am making the same points over and over again.

  497. We are in danger of going round and round.
  498. (Ms Lomax) You deserve to have the best written account we can on this important point. I will end by saying we have not seen the NAO's work, I am sure it is up to perfect standard, we have not seen it, and it would be good if we could see it now please.

    Mr Jenkins

  499. The pension fund, normally companies take holidays from making a contribution because the stock market is very high and they have figures that show they can meet their obligations. In a case where we take a pension holiday because of the financial position of a company, Ms Lomax, as a majority shareholder in this corporation would you realise how embarrassing it would be if the company would fail in its obligations or meet its obligations to the pension fund. Are you taking a very close role in monitoring to ensure that this will not happen?
  500. (Ms Lomax) I personally am not but I am sure the partnership directors we have appointed to represent the interests of the government certainly are.

  501. Can you guarantee you will not come back and say, we cannot meet our obligations in the pension fund?
  502. (Ms Lomax) I cannot give you any guarantee of that sort, nobody ever can.

    Mr Howarth

  503. Can I make a brief point, it seems to me the reason we have probably spent the last half hour or more of this extended meeting of the Committee is that when the Department, presumably the Permanent Secretary, signed off the NAO's Report they were accepting the integrity of the comparison that the NAO were making. I think it would have been better if you had doubts about that to have taken that up at the time, it might have saved a lot of difficulty here today and us getting into a lot of territory that has become baffling to many of us.

(Ms Lomax) I fully accept that and I apologise to the Committee. I think I got dragged into it as a result of trying to justify the amount of stress testing that had been done. I think it is a highly complicated and technical area. If I have confused the Committee I will try and put it right when I send a further note.

Chairman: Thank you very much, Ms Lomax and Mr Everitt, for coming to see us. We will obviously return to this in our report. As you might imagine, we may have a lot to say about whether the way this PPP was handled put the company into financial distress. Before I end I am indebted to Mr Geraint Davies for a quote from Adam Smith who wrote this a long time ago: "The tolls for the maintenance of the high road cannot with any safety be made the property of private persons because they might neglect altogether the repair of the road and yet continue to levy very nearly the same tolls." Let's hope we can learn from the wisdom of the past. Thank you very much.