Conclusions and recommendations
1. The cause of Connex South Eastern's (CSE's)
financial difficulties lay in an ambitious franchise bid which
the Strategic Rail Authority's (SRA's) predecessor, the Office
of Passenger Rail Franchising (OPRAF) accepted in line with its
policy of awarding franchises to bidders requiring the least public
subsidy. The termination
of CSE's franchise shows that franchising cannot transfer to train
operating companies all the financial risks of operating trains.
To reduce the risk of future franchise failures, the Department
should base franchise award decisions on a balanced and transparent
assessment of costs and the realism and deliverability of the
assumptions and plans on which a bid is based.
2. OPRAF recognised at the time of franchise
award that CSE's bid was ambitious, but neither OPRAF nor the
SRA adapted their franchise monitoring to manage the associated
risks. The Department should identify
train operating companies at greatest risk of financial or operational
failure, target its monitoring accordingly and use variations
against key performance measures as an 'early warning system'
of problems arising.
3. Periodic viability reviews during the lifetime
of the franchise would have detected CSE's emerging financial
difficulties more quickly. At the point
of franchise award, not all developments which may impact on passenger
revenues and operating costs across the franchise term can be
foreseen with certainty. The Department should carry out continuing
viability reviews at appropriate points throughout franchises
and discuss the results with train operating companies to achieve
a common understanding of the strengths and weaknesses of the
franchise going forward.
4. The proposed provision of further subsidies
to CSE of £183 million for 2004-06 was not made conditional
on identified improvements in financial management, controls and
reporting. Where a franchisee is required
to take remedial actions, the Department should make provision
of further subsidy conditional on delivery of the remedial actions
required. It should specify the time period allowed for implementation
and agree with the franchisee how improvements in performance
will be measured.
5. The costs of terminating CSE's franchise
amounted to some £6.4 million, making termination a costly
option. The Department's franchise management
procedures should therefore set out a range of remedial actions,
and the criteria and circumstances in which they would be applicable,
together with some consideration of the potential costs, risks
and benefits of each option.
6. The SRA recovered only £2.8 million
of its £6.4 million losses, liabilities and expenses
from CSE's Performance Bond of £19.5 million because
it was concerned that further action might lead to CSE's insolvency,
potentially triggering liabilities to rolling stock leasing companies
(ROSCOs). In practice, the SRA entered
into agreements with the ROSCOs to guarantee future lease payments
to secure the continued availability of rolling stock to SET and
its successor. The Department should take a more robust line on
cost recovery in future.
7. The SRA spent some £2 million on consultants'
reviews of CSE's financial performance, but a failure to specify
clearly the work required led to duplication of effort and unnecessary
expenditure. When commissioning consultants,
the Department should specify clearly what is required, and how
findings should be reported and shared, including with the franchisee.
8. Misunderstandings arose between the SRA
and CSE, reflecting ineffective communications and a lack of mutual
trust. Train operating companies and the
Department should have open dialogue and transparency in their
dealings at all times. When franchise difficulties arise the Department
may need to consider putting in place special measures to strengthen
communications such as taking advice from a skilled arbitration
service to forge effective negotiation and open communication
between the parties.
9. The Department's franchise management and
monitoring will only be effective if staff have the necessary
skills to interpret and question financial information.
The Department should put in place the right resources and skills
to provide robust, risk based monitoring to avoid another case
of late identification of franchise failure.
10. Overall, the transfer of CSE's operations
to SET went smoothly and led to improvements in passenger services.
The Department should reflect the lessons of the CSE case in its
franchise termination contingency plan, and also in its franchising
and monitoring activities.
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