House of Commons - Transport

Select Committee on Transport Second Report

4 THE POWERS OF THE ARBITER

Reporting on the performance of the Infracos

46. There are two mechanisms under the PPP Agreements for monitoring and reporting on the performance of the Infracos:

a) London Underground has responsibility as the customer for monitoring delivery of the obligations in the contract and has produced an annual report on performance under the PPP for each year other than 2006-07.

b) The Arbiter, at the request of London Underground and Metronet produces a report on economy and efficiency and Good Industry Practice.[65]

47. Under the terms of the two Metronet Agreements, the Arbiter could be asked annually to prepare a report on performance (no provision for an annual performance reporting by the Arbiter exists in the Tube Lines contract). This process was intended by Metronet to enable each Metronet Infraco to understand on an ongoing basis whether it was meeting the criteria of efficiency and economy and Good Industry Practice contained in the PPP Agreements and, if not, to identify the areas in which improvement was required in order to ensure that those criteria were met as soon as possible, and certainly before the first Periodic Review.

48. The Arbiter contends that such a report would have identified the following:

a) the scale of the shortfall in delivery by Metronet, in particular on the stations and track programmes;

b) the emerging projected overspend, which by late 2005 already exceeded the Materiality Threshold for Metronet BCV; and

c) weaknesses in financial and risk management, and in management of the supply chain.[66]

49. The Arbiter expected a request to prepare the first Metronet annual performance report in 2005, to cover the two year period from Transfer in April 2003. However, he told us that, in the event, it was agreed by Metronet and London Underground not to seek the 2005 report, and that Metronet secured a waiver from its funders to permit this.[67] Metronet's former Chairman, Graham Pimlott, who was appointed in 2007, thought that Metronet "wanted to try to sort [its] difficulties out with London Underground before subjecting itself to a public examination."[68]

50. The Arbiter considered the absence of a report in 2005 to have been detrimental:

In particular, he took the view that a 2005 report would have made it clear at an early stage to shareholders and lenders that some of the costs to date had not been incurred by Metronet in an efficient and economic manner, and were not therefore recoverable from London Underground, and that early action was therefore essential if financial difficulties were to be avoided.[70] When the Arbiter did come to produce his first Metronet Report in 2006, he concluded that progress under the main performance measures had been mixed and that neither of the Metronet Infracos had performed in an efficient and economic manner, or in accordance with Good Industry Practice.[71]

51. On the whole the Arbiter reported that Metronet had delivered significantly less than was expected in its bids, at higher unit costs, and had earned less performance revenue than expected. For example, over the first three years of its contract, Metronet SSL delivered 10 of an anticipated 18 station refurbishments, at a unit cost of £7.5 million rather than the expected £2 million. Metronet BCV delivered only 4 of 17 anticipated stations. Track renewals were also grossly behind schedule. The Arbiter identified asset management and risk management as important weaknesses. He recognised that Metronet had introduced a number of initiatives over the previous year to address shortcomings in its performance and to put more emphasis on whole-life asset management. He considered that these changes had helped to improve Metronet's performance but that the full benefits of the changes had yet to be realised.

52. Metronet announced a number of important changes on 13 March 2007:[72]

a) Following a competitive tender process, the first tranche of six contracts for station upgrades worth more than £150 million was awarded outside of its tied supply chain in early 2007. Metronet had accelerated its station upgrade programme in the previous year but planned to complete the balance of 84 stations using an open competitive tendering procedure.

b) Metronet had converted the contract for its track renewal programme into a Metronet/ Balfour Beatty alliance in an attempt to take advantage of lessons learned from the first two years and improved performance in the third year. Metronet had also invested £80 million in a new engineering train fleet to boost delivery of its programme.

c) 550 additional front-line staff were being recruited to support the move to a planned, preventative maintenance regime and priority was being given to the engineering issues which have the potential to create the greatest adverse impact.

d) A new independent non-executive chairman (Mr Pimlott) and three senior independent advisors had been appointed in an attempt to ensure Metronet had access to best practice in the international market.

53. Mr Pimlott recognised that the Arbiter's 2006 report been a significant factor in encouraging Metronet to address its poor performance and conceded that a report in 2005 might have been similarly beneficial.[73] The Secretary of State agreed that there were not adequate systems in place to highlight poor performance and that Metronet's contract should have incentivised more strongly the production of the 2005 annual performance report.[74] Tim O'Toole of London Underground expressed serious concerns over the lack of information that was available in order for LUL to assess the performance of the Infracos and called for clearer specification in the PPP contracts with respect to information sharing and transparency.[75] However, he rejected the assertion that the production by the Arbiter of a report in 2005 would have significantly improved Metronet's performance, describing the annual review as something that was incorporated into the agreement "by Metronet to protect Metronet". London Underground was

54. The Secretary of State indicated that a formal power to allow the Arbiter to report on the performance of the Infracos unbidden might not be required and that there might be other ways of ensuring that poor performance is addressed.[77] The DfT's Paul Collins, Head of Regional Transport London and South East, told us that the Arbiter's reporting powers and the clear and timely provision of information were areas that the Department would be looking at very carefully.[78]

55. We consider that the gathering and publication of information by the PPP Arbiter will generally tend to benefit all interested parties: London Underground as client, the Infracos as suppliers and the public as users. The Government should also find such information useful for assessing the benefits and costs of similar proposals in the future. There is some evidence to indicate that an earlier review could have mitigated the impact of Metronet's collapse, if not averted it entirely. However, it is important that any reporting process is seen as neutral and is designed to provide the information that both the Infracos and London Underground require to address performance issues and to prepare for Periodic Review. It would have been wiser to make the annual review an automatic process rather than one which had to be initiated by a party to the contract.

56. Though we have not sought to evaluate Tube Lines' performance in the course of this inquiry, we believe that, in principle, annual reports on Tube Lines would be just as valuable as it could have been in the case of Metronet. An independent report from the Arbiter in 2008 on the performance of Tube Lines to date would be timely, particularly in the absence of a 2006-07 London Underground report on the performance of the Infracos.

57. We recommend that a mechanism be put in place to allow the PPP Arbiter to report annually on the performance of the Infracos, including Tube Lines, whether or not he is called on to do so; this might require the granting of additional powers to the Arbiter under the Greater London Authority Act 1999.

58. If part of the management of the Tube upgrade programme is to come back under public control in the long-term, the requirement for transparency in terms of progress and value for money will not be diminished. The Arbiter, giving evidence before TfL took over Metronet, suggested that it would "remain important to benchmark performance between Metronet and Tube Lines to establish and demonstrate value for money" if Metronet were to come into public ownership and that there would therefore still be a need for some independent body or person to be involved in that benchmarking performance.[79] He also noted the importance of benchmarking against the performance of Network Rail for tasks that it has in common with the Infracos, such as track renewal.[80]

59. When Transport for London takes over the Metronet companies, it will effectively be on both sides of the contracts, as purchaser and provider. It therefore appears unlikely that the Arbiter will be requested to perform his functions in relation to Metronet. As long-term arrangements for upgrading the Tube are devised, the Government should ensure that there is a mechanism to guarantee independent reporting of progress and value for money, no matter what delivery vehicle takes the place of Metronet's PPP Agreements.

The performance of London Underground

60. Metronet have previously blamed cost overruns on a wasteful approach to job specification by London Underground and a misconception by London Underground that the PPP Agreements represent fixed-price contracts. Metronet contends that it has sought to make London Underground aware of the financial impact of changing requirements and that London Underground has not re-defined the scope of the works to keep the overall cost to that set out in the PPP Contract. London Underground, in Metronet's view, has continued to act as if the PPP contract were a fixed price contract, whilst at the same time seeking to secure more scope and increased specification.[81] Mr Pimlott told us that there had been "some difficulty in interpreting what the area of the contract relating to stations truly meant."[82] Metronet had assumed that stations would be put into one of three categories to be given varying levels of refurbishment but Mr Pimlott explained that the stations were "more unique than that" and the client's requirements were different from those for which Metronet had bid.[83] He asserted that if the original specification had been clearer many of Metronet's problems on the stations programme would have been avoided.[84]

61. On the other hand, Tim O'Toole thought that Metronet's differences of opinion were mainly with its subcontractors—resulting in "armies" of people "standing around and nothing getting done."[85] In any case, the Arbiter suggested in his 2006 report that there could be considerable benefit in terms of value for money if Metronet and London Underground were to "adopt procedures which allowed the specification of works, for example at stations, to be agreed without recourse to dispute resolution, and to have a single process for agreeing the appropriate payment if efficient and economic costs are above those provided for".[86]

62. In his September paper on the likely outcome of the Metronet Extraordinary Review, the Arbiter estimated that London Underground could be liable for £370-1,070 million of Metronet's projected overspend during the first 7½ years of the contracts.[87] This judgement is primarily the result of efficiently undertaken work that was not costed in the original bids.

63. A contractual arrangement which fails to incentivise efficiency in the private sector and at the same time fails to deter poor planning, lack of forethought and gold-plating in the public sector is one which is pretty much useless. Metronet alleges that part of its overspend is a consequence of decisions by London Underground, such as changes to the specification of ongoing works. We recommend that in the future the Arbiter, alongside reporting the performance of the Infracos, reports the effectiveness of London Underground as client during the modernisation of the Tube network.

The Extraordinary Review

64. The process of Extraordinary Review is designed to determine the respective liabilities of an Infraco and London Underground in the event of an increase in costs. London Underground is liable to remunerate the Infracos for costs that are efficiently incurred, even if they were not anticipated in an Infraco's bid. Responding to the Arbiter's 2006 performance report, which noted a projected overspend of £750 million by 2010, Metronet blamed a significant part of the cost variance on "bid omissions" (i.e. work that was required but not anticipated in the original bid), or attributed it to the effects of the assets being in a different condition from that expected at the time of the bid, and was seeking to negotiate additional payments from London Underground. Mr Pimlott described the situation:

As I understand it, the view of London Underground was that the work had been bid for and therefore if more work was done the contractors would have to swallow it, and the view of the contractors was that if more work had been done and it was done efficiently, economically and in accordance with good industry practice, they would be paid for it. That difference of opinion, in my view, when applied to the facts, was the reason for doing the Extraordinary Review.[

65. London Underground made it clear publicly in February 2007 that it did not consider it possible to reach a negotiated settlement with Metronet over its cost increases and that Metronet should use its contractual right to seek an Extraordinary Review to recover the additional sums that it was claiming. However, the Arbiter did not receive a request for an Extraordinary Review from Metronet BCV (subsequently withdrawn) until June 2007 and has not been asked to undertake such a review of Metronet SSL's costs. Mr Pimlott acknowledged that it would have been better if there had been an earlier Extraordinary Review,[89] and the Arbiter considered that, had a Review been started twelve months earlier, some of Metronet's additional costs might have been avoided.[90]

66. As with the annual report, there is evidence that had the Extraordinary Review been initiated at an earlier stage, it might have mitigated the worst effects of Metronet's failure. We recommend that, for future PPP Agreements, the Government extend the power to trigger an Extraordinary Review to both contract parties, rather than only the Infracos. Such a change could reduce the possibility that an overspend would be allowed to get as far out of control as it did in the case of Metronet.

67. In order for Tube Lines to seek additional payments from London Underground, it would first be required to submit to assessments by the Arbiter of non-recoverable cost increases (i.e. efficient cost increases below its Materiality Threshold of £200 million) in £50 million tranches (although to date relatively effective cost controls have ensured that this mechanism has not yet been necessary). The Arbiter, who was not asked to take a view as to whether cost overruns were efficient or not until they had surpassed the Materiality Threshold by many times,[91] suggested that a mechanism to oblige Metronet to seek a determination at an early stage should have been included in its PPP Agreement. This, he indicated, would have resulted in a clear allocation of responsibility for cost increases between London Underground and Metronet and would have forced earlier action to address some of the problems that Metronet experienced.[92]

68. The Secretary of State also told the Committee that the incentives which were built into Metronet's contract to encourage it to seek an early opinion from the Arbiter as to liability for cost overruns were not "sharp" enough. She also thought that cost overruns had been allowed to build up without anybody being clear whose responsibility it was to address them.[93]

69. The uncontrolled spiral of cost overruns, without any assessment being made of its causes or of the respective liabilities of the parties to the contract, must never be allowed to happen again. A mechanism similar to that which is built into the Tube Lines contract to ensure an early examination of any cost increases should be included as a matter of course in any future contracts.

65 This is the description of the monitoring process given to us by the Arbiter, Mr Bolt, at Q12. Back

66 Ev 47 Back

67 Q 13 and Ev 48 Back

68 Q 189 Back

69 Q 16 Back

70 Ev 49 Back

71 Office of the PPP Arbiter, Annual Metronet Report 2006, 16 November 2006 Back

72 "Metronet responds to PPP Arbiter's Guidance on Additional Costs", Metronet press release, 13 March 2007 Back

73 Qq 190-193 Back

74 Qq 336-337 Back

75 Q 240 Back

76 Qq 260-268. Back