Memorandum from Chris Bolt, the PPP Arbiter
(PPP 01)
THE ROLE
OF THE
PPP ARBITER
1. The functions and duties of the PPP Arbiter
were established by the Greater London Authority Act 1999 (GLA
Act). The PPP Arbiter's role is principally to ensure that any
differences between the PPP Parties about the price to be paid
to the Infracos for carrying out obligations under the PPP Agreements
can be resolved independently, with certainty and in a timely
way.
2. Although the Arbiter can be asked for
guidance or directions at any time, it was expected that he would
exercise formal functions in three main circumstances:
— in giving an annual "definitive
statement" on the performance of the two Metronet infracos;
— at the Periodic Review of the Agreements
which takes place every 7½ years; and
— at an Extraordinary Review of the
terms of a PPP Agreement if there were material changes in costs
and revenues within a Review Period.
3. The PPP Agreements establish the concept
of a "Notional Infraco"—an entity which has the
same obligations as Infraco, which carries out its activities
in an overall efficient and economic manner and in accordance
with Good Industry Practice, and has certain other specified characteristics.
A key part of the Arbiter's role is therefore to assess what constitutes
Good Industry Practice and the level of performance and cost which
would be efficient and economic.
4. Chris Bolt was appointed as the first
Arbiter on 31 December 2002, and his appointment now runs to 30
December 2010. He is supported by a small permanent staff. As
he is appointed as an individual, and is personally responsible
for the exercise of his statutory functions, he has also appointed
an Advisory Board to provide independent and expert challenge
to his decisions and procedures. Although he is not required by
statute to do so, he has published each year a Business Plan and
the Annual Report and Accounts setting out the work programme
of his Office and the resources used.[1]
ACTIVITIES TO
DATE
5. The Arbiter's initial focus was on two
main workstreams:
— developing clear and transparent
procedures for handling references, which have been published—after
consultation—as a "Procedural Framework for Use in
the Giving of Directions and Guidance" together with a series
of more detailed supporting documents relating to different types
of reference; and
— initiating a programme, jointly with
the PPP Parties, to develop a basis for assessing the key concepts
of efficiency and economy and of Good Industry Practice; this
has included developing a framework for benchmarking between the
infracos, initial work on international benchmarking and specific
studies on aspects of good practice in asset management, procurement
etc.
6. The two Metronet Agreements provide for
an annual reference to the Arbiter for guidance in the form of
a definitive statement as to whether "Infraco has performed
its activities in an overall efficient and economic manner and
in accordance with Good Industry Practice" or not (the "annual
Metronet Report"). It was expected that the first report
would be prepared in 2005, covering the two year period from Transfer
in April 2003. Preparing for this reference was an early priority
for the Arbiter and his Office.
7. In the event, it was agreed by Metronet
and London Underground not to seek this independent report from
the Arbiter in 2005, and Metronet secured a waiver from their
funders to permit this.[2]
Although Metronet and London Underground agreed to undertake,
with the Arbiter, some preparatory work for the 2006 report, which
enabled some issues such as the presentation of variance analysis
to be taken forward, a significant consequence of this decision
was that the emerging overspend in Metronet was not fully analysed
for a further 12 months.
8. Five references were made to the Arbiter
for guidance in the year 2006-07:
— a reference from Tube Lines for guidance
on the treatment of investment which straddles a Periodic Review;
— references from Metronet BCV and
Metronet SSL for the 2006 annual report; and
— references from Metronet BCV and
Metronet SSL for guidance on the treatment of investment at an
Extraordinary Review.
9. These references were handled in accordance
with the Procedural Framework. The final guidance in each case
has been published.
10. Of particular significance was the annual
Metronet Report 2006, published on 16 November 2006. This concluded
that neither of the two Metronet infracos had performed its activities
in an overall efficient and economic manner and in accordance
with Good Industry Practice in the first three years of the contract.
The report made some specific criticisms of the supply chain arrangements
which Metronet put in place at Transfer, and of Metronet's governance.
The Arbiter also expressed surprise at the lack of detailed information
on important aspects of Metronet's activities.
11. The report also identified a significant
overspend, at that stage estimated at about £750 million
for the two infracos combined, for the first 7½ year Review
Period. To the extent that an Extraordinary Review concluded that
these additional costs were efficiently incurred, all but £100
million would be borne by London Underground (either through additional
Infrastructure Service Charge (ISC) or through a reduction in
obligations); costs inefficiently incurred would be borne by the
relevant infraco.[3]
Given this scale of overspend, the Arbiter considered that it
was important to clarify the responsibility for cost overruns
through an Extraordinary Review.
12. The Arbiter had discussed with Metronet
the possibility of their making a reference for direction on Eligible
Costs and ISC (essentially a determination of the increase in
efficient and economic costs and revenues above the contractual
baseline) alongside the 2006 annual report, but in the event Metronet
did not make that reference.
13. Initially, Metronet considered that
it was preferable to negotiate a settlement with London Underground,
rather than use the contractual processes. Anticipating the possibility
of an Extraordinary Review, Metronet made a further reference
to the Arbiter for guidance on the treatment of seven specific
investments at an Extraordinary Review on 14 November 2007, and
the Arbiter's final guidance was published on 13 March 2007. Although
London Underground and the Mayor were publicly urging Metronet
to call an Extraordinary Review from February 2007, the Arbiter
did not receive a reference until June 2007.
METRONET EXTRAORDINARY
REVIEW
14. Metronet BCV made a reference to the
Arbiter for an Extraordinary Review of its PPP Agreement on 28
June 2007. This sought three separate directions: on the form
and structure of the Extraordinary Review, on Net Adverse Effects
and the consequent increase in ISC for the full 7½ year Review
Period, and on an interim increase in ISC ("Interim ISC")
while the Extraordinary Review was being conducted.
15. Draft directions on Interim ISC, covering
a 12 month period to 28 June 2008, were published on 16 July 2007.
These directions allowed Metronet BCV only £121 million of
the £551 million interim funding the company had sought.
On 18 July, both Metronet BCV and Metronet SSL entered PPP Administration.
16. To allow the Administrators time to
develop their plans for Metronet, and reflecting the availability
of alternative interim funding, the Arbiter suspended on 30 July
the previously announced timetable for the Extraordinary Review
which covered the publication of final directions on Interim ISC
and holding a post-reference meeting to establish the timetable
for the full Review. However, he also said that he was continuing
work on analysing submissions from Metronet BCV and London Underground.
17. The Administrators of Metronet have
told the Arbiter that they do not currently envisage withdrawing
the reference, and indeed are considering whether to make a reference
for an Extraordinary Review of Metronet SSL's Agreement. Because
the Metronet BCV reference remains on the table, the Arbiter is
under a statutory obligation to give directions. On 21 September,
he published his Initial Thoughts on both the level of efficient
costs and revenues for Metronet BCV, and the potential implications
for Metronet SSL, and on the form and structure of the whole Extraordinary
Review. He has asked for representations by 12 October.
18. The Arbiter's current proposals in respect
of Metronet BCV envisage draft directions on Net Adverse Effects
being published on 12 November, with final directions on 14 December.
Draft and final directions on the resulting changes in ISC will
follow, with the process being completed in January 2008, unless
additional time is required to assess the impact of changes in
Infraco Obligations on affordability or practicability grounds.
THE PERIODIC
REVIEW
19. The Arbiter is continuing his preparations
for the first Periodic Review of the contracts, due to be completed
in 2010. The current focus is on the format of cost and performance
information to be provided, and the internal and external benchmarks
which will assist in evaluation of infraco projections. The Arbiter's
office now chairs the Joint Benchmarking Steering Group, and the
Arbiter chairs regular meetings with Metronet, Tube Lines and
London Underground to review overall progress.
20. The current programme for the Periodic
Review envisages that the business plan currently being developed
by each infraco will provide the basis for an initial assessment
by London Underground of affordability in the second Review Period
(2010-17/18) and by the Arbiter of efficiency and economy. The
results will allow an updated business plan to be developed at
the end of 2008 as the basis for detailed negotiations between
infracos and London Underground, and any directions by the Arbiter,
during 2009. New pricing and financing arrangements need to be
in place by the start of the second Review Period (1 July 2010
for Tube Lines, 4 October 2010 for Metronet).
ISSUES RELEVANT
TO THE
CURRENT INQUIRY
21. Under the terms of the PPP Agreements,
the infracos are incentivised to deliver improvements in three
main output measures: capability (in terms of capacity and journey
times); availability (performance of trains on the day); and ambience
(of both stations and trains). They are also required to deliver
a station improvement programme in line with dates specified in
the Agreements. The infracos are under an obligation to demonstrate
an efficient and economic whole-life cost approach to asset management,
by reference to Good Industry Practice.
22. Since Transfer, performance of the Infracos
on the availability measure (train performance "on the day")
has generally been better than the level in the two years before
Transfer, although the improvement has been different for different
lines. Delivery of the stations programme has also varied between
the infracos, with Tube Lines delivering on time, but Metronet
delivering substantially later than the contractual dates. Tube
Lines is also projecting costs in the first Review Period broadly
in line with bid, in contrast to the overspend under the two Metronet
Agreements.
23. Although the Arbiter has no role in
establishing the obligations to be delivered under the PPP Agreements,
or in monitoring and enforcing delivery of those obligations,
his guidance and directions are central to delivery of value for
money under those Agreements (as recognised by the National Audit
Office in their report on the PPP).
24. The Arbiter identified in his guidance
on investment which straddles a Periodic Review, issued in November
2006, some weaknesses in the PPP Agreements in giving adequate
incentive to the infracos to innovate where this increased costs
in the short term but brought longer term benefits. Recent events
have also highlighted some areas where the PPP Agreements may
not be fully effective in promoting value for money. These include
the arrangements for updating and reviewing business plans, provisions
relating to the triggering of an Extraordinary Review, and the
provisions for handling delay in the delivery of obligations.
There are also questions about the effectiveness of lenders in
using their powers under the funding agreements to hold Metronet
to account.
25. It also seems clear that there have
been differences of understanding between Metronet and London
Underground about the allocation of different risks under the
contract. In particular, the cost consequences of increases in
the scope of work required to deliver obligations are mostly borne
by London Underground; only the (low) Materiality Threshold and
the cost consequences of delivering inefficiently are borne by
Metronet. Thus, even where sums were omitted from the original
bid, or disputes about contractual requirements have been won
by London Underground (such as whether Low Loss Conductor Rail
for the Victoria Line was an original obligation or not), London
Underground still has to bear the efficient increase in costs.
26. Quantification of risk will be particularly
important in assessing the value for money of different options
for the future structure of Metronet, in particular if this involves
a comparison of public and private sector ownership models. Experience
in developing the Public Sector Comparator (PSC) at the time of
the original contract award may be particularly relevant. It should
also be borne in mind that the PSC for SSL was assessed as being
between £500-£1000 million more expensive than the Metronet
bid for the first 7½ years.[4]
27. Uncertainties surrounding the future
structure and ownership of Metronet (in both the short and longer
term) make it particularly difficult to plan effectively for the
Periodic Review, in particular given the expectation that comparisons
between the three infracos would be a primary source of information
for the Arbiter. However, the Arbiter remains of the view that
the basic structure of the PPP Agreement remains sound, and that
maintaining an output-based contract is important for delivering
value for money in the longer term.
1 These are published on the Arbiter website, at http://www.ppparbiter.org.uk/output/page19.asp?DocTypeID=4. Back
2
Although the annual report is specifically referred to in the
PPP Agreements, the reference is discretionary. However, Metronet's
funding agreements make it mandatory that such a reference is
made by 30 April in each year from 2005. Back
3
Changes in the efficient level of costs and revenues are referred
to in the Agreements as Net Adverse Effects. Net Adverse Effects
in excess of a Materiality Threshold are borne by London Underground.
The Materiality Threshold is £50 million indexed in each
Review Period for the Metronet infracos, and £200 million
indexed for Tube Lines in the first Review Period and £50
million in subsequent Review Periods. Back
4
Present value over 7½ years. Source: Final Assessment
Report, 2 February 2002, Table 20.1. Back
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