Memorandum from the PPP Arbiter (UPP 02)
INTRODUCTION
1. The role of statutory Arbiter for the
London Underground Public-Private Partnership Agreements was created
by the Greater London Authority Act 1999. I was appointed as the
first PPP Arbiter in December 2002, and my appointment runs to
30 December 2010. My role is concerned principally with assessing
the efficient level of costs and pricing at Periodic Review (and
at the Extraordinary Reviews which may take place between Periodic
Reviews). Annex 1 summarises my functions and duties.
2. Based on my experience to date, I set out
below my views on some of the questions covered by the call for
evidence. I do not respond on questions which are outside the
scope of my role as PPP Arbiter. Nor do I comment on matters directly
related to the Periodic Review of Tube Lines' PPP Agreement which
are the subject of a reference to me from London Underground dated
23 September 2009.
What lessons can be learned from the collapse
of the London Underground PPP Agreement with Metronet?
3. My views on the collapse of Metronet were
set out in evidence to the Committee in 2007, when it last considered
the London Underground PPP.[1]
4. I consider that the main lessons which are
relevant to the management of the PPP Agreements are that their
effectiveness depends on:
— an agreed base plan, to enable effective
monitoring of both costs and performance;
— a clear understanding between the contract
parties about the allocation of risk, with effective monitoring
of key risks, in order to incentivise delivery by the infracos;
— regular independent reporting on the
performance of the infracos; and
— provisions which prevent an Infraco deferring
a request for Extraordinary Review once it is clear that increases
in costs are likely to exceed the Materiality Threshold.
5. In terms of delivery, there was a general
consensus that Metronet's governance was ineffective and that
this, coupled with its supply chain structure, made a major contribution
to its failure. Tube Lines competitively tendered its major contracts,
for example in respect of the signalling upgrades for its three
lines, although secondment agreements with its shareholders, Bechtel
and Amey, give those companies a major role in managing major
projects and operations respectively. In preparing for a Periodic
Review reference, I have sought advice on whether this approach
to procurement and project management has delivered an outcome
consistent with that of a Notional Infraco.[2]
6. Although London Underground has claimed
savings of £2.5 billion as a result of taking Metronet in-house,
this largely reflects reductions in costs from levels which, as
part of my uncompleted 2007 Extraordinary Review of Metronet,
I had concluded were inefficient. It is too early to make a robust
comparison between the costs of public sector and private sector
provision of infrastructure services. However, the report on Phase
V of the joint benchmarking programme comparing the operating
expenditure of Tube Lines with the former Metronet companies,
which covers 2008-09, will be available shortly. Initial results
from the draft analysis undertaken for this report suggest that
the former Metronet companies' maintenance costs for track, signalling,
stations, lifts and escalators have risen in 2008-09 compared
with 2007-08 levels. The draft analysis also reinforces previous
year's benchmarking results which have found Tube Lines' maintenance
costs to be lower on average than for the former Metronet companies.
Are these lessons being applied to the London
Underground PPP Agreement with Tube Lines?
7. As part of the preparation for the Periodic
Review, my Office has developed a format for the submission of
information about future costs (the "Data Breakdown Structure"—DBS)
which both London Underground and Tube Lines have agreed to adopt.
This will ensure consistent provision of information, which London
Underground is also following for the former Metronet companies.
In particular, it will facilitate monitoring of costs and activities
against plans, and make it easier to compare performance both
between the infracos and with external comparators.
8. Under the terms of the PPP Agreement, an Infraco
is protected, through the Extraordinary Review mechanism, against
all changes in the efficient cost of delivering its contractual
obligations, except for the first £50 million in each 7½
year period.[3]
This is only about 1% of the contract value. An important part
of the Periodic Review is therefore establishing an appropriate
allowance for risk. If this is too high, London Underground could
pay too much for the contract; if it is too low, an early Extraordinary
Review could be required, which would impact adversely on incentives
to deliver improved efficiency over the whole Review Period.
9. I have also, therefore, discussed with
the Parties through the regular tripartite meetings which I chair
the linkage between the risk allowance at Periodic Review and
the form and conduct of the Extraordinary Review mechanism in
the second Review Period. This will now be considered further
as part of the Periodic Review reference.
10. Under Metronet's PPP Agreements, it
was envisaged that the Arbiter would report annually on efficiency
and economy. In the event, I was only asked to carry out one such
annual review, in 2006, before Metronet went into administration.
Although the Metronet PPP Agreements remain in place, London Underground
has indicated to me that it does not propose to seek annual reports
in future.[4]
The Committee recommended in its last report on the PPP that a
mechanism be put in place to allow the PPP Arbiter to report annually
on the performance of all the Infracos, including Tube Lines,
whether or not he is called on to do so; the recent report from
the National Audit Office[5]
made a similar recommendation.
11. Unless the Arbiter's role is extended
in the way the Committee recommended, the future role of the Arbiter
would be restricted to Periodic and Extraordinary Reviews of the
Tube Lines Agreement alone. With this restricted role, and no
regular reporting function, it would be difficult to retain or
recruit staff of the current calibre beyond the current Periodic
Review. This could seriously prejudice the effectiveness of the
Arbiter's statutory role, for example by losing continuity in
the benchmarking work which I have initiated.
12. If the Arbiter was able to prepare and
publish regular assessments of Infraco performance, it might not
be necessary to make contract changes to prevent an Infraco deferring
a request for Extraordinary Review (or giving London Underground
the right to trigger such a Review). With that degree of transparency,
it is much less likely that lenders would waive the requirement
to seek Extraordinary Review than was the case with Metronet.
How has the upgrade work progressed since the
demise of Metronet?
13. It is currently difficult to make a
full assessment of the upgrade projects, given that most are still
under way, and because of changes in reporting arrangements for
Metronet following administration. The Arbiter is working with
London Underground to develop information that would permit him
to monitor the Metronet upgrades and use data gathered in this
way as a benchmark for Tube Lines.
14. The Arbiter's Independent Reporter has reviewed
the basis of London Underground's cost projections for the former
Metronet companies and raised a number of concerns about the robustness
of the projections.[6]
A further review will be undertaken by the Reporters in the New
Year.
What contractual arrangements are appropriate
for the future?
15. Experience with the PPP Agreements over
the first Review Period suggest that areas where contractual changes
might be considered for the future include the following:
— a requirement to produce data in a stable
(DBS) format that tracks progress against the financial baseline
for Net Adverse Effects;
— a requirement for Infraco to prepare, in
DBS format with appropriate commentary, a delivery plan for each
Review Period following completion of the Periodic Review;
— an annual review (either by London Underground
or the Arbiter) of contract delivery based on a comparison between
updated plans for the remainder of the Review Period and the delivery
plan;
— clarification of the treatment of investment
to deliver improved efficiency where the payback period straddles
a Periodic Review;[7]
— clarification of the potential overlap
and conflict between Extraordinary Review and contractual claims;
— clarification of overlapping jurisdiction
between the Arbiter and an Adjudicator at Periodic Review, for
example in relation to financeability; and
— review of the Extraordinary Review mechanism
given the lower materiality threshold for RP2.
16. Although a number of these matters are
covered by "entrenched provisions", which means that
London Underground is unable to propose changing them as part
of the Periodic Review, I have the power in giving directions
to make directions which are ancillary and incidental to the matter
referred.[8]
As with all my directions, these have the effect of modifying
the contract unless both Parties agree to set the directions aside.
I will therefore want to consider as part of the Periodic Review
reference whether there are matters in respect of which I have
the power to make such ancillary or incidental directions in order
better to achieve the objectives set out in my statutory duty.
17. I have no role in respect of contractual
arrangements which are not designated PPP Agreements. This includes,
for example, the proposed contract for resignalling of the Sub-Surface
Lines. However, many of the principles outlined above are equally
relevant to other contractual models.
18. Given my limited remit, it would not
be appropriate to comment in detail on alternative contractual
models. However, I have previously compared the PPP structure
with the regulation of the national rail network,[9]
noting the greater flexibility under a licence structure than
under a contract. My conclusion then was that "if the Parties
are able to agree changes in the incentive structures where there
are weaknesses, learning from the experience of the regulated
utilities, then the outcome in terms of efficient delivery of
customer requirements could be very similar to that achieved by
economic regulators—even with an Arbiter reacting to disputes
rather than driving the process. But if these opportunities cannot
be taken, then the superiority of a licence structure will have
been demonstrated." I stand by that conclusion.
What risks, if any, are associated with the PPP
Agreement with Tube Lines?
19. The main risks associated with Tube
Lines' PPP Agreement are, in my view, as follows:
— inability for Tube Lines to finance the
difference between the efficient costs of delivering contract
obligations in the second Review Period and London Underground's
Affordability Constraints, leading to a requirement to descope
or, in certain circumstances, Special Mandatory Sale;
— increases during the second Review Period
in efficient costs of delivering contract obligations, leading
to additional ISC payments by London Underground, or a requirement
to descope for affordability reasons, at an Extraordinary Review;
— financial failure as a result of Tube
Lines incurring costs inefficiently, or failing to deliver contract
obligations as a result of inefficiency; and
20. I have yet to make any directions under
the provisions of the GLA Act, which inevitably creates a degree
of uncertainty about the basis on which I would reach decisions.
I have sought to mitigate this by:
— consulting on, and publishing a Procedural
Framework for handling references, with accompanying Procedural
Approach documents for different types of reference updated in
the light of experience;
— sharing technical reports and advice
(for example benchmarking reports) with the Parties, seeking comments
on that advice, and in most cases publishing the reports;
— responding positively to requests for
guidance, even where I have discretion not to give it,[10]
and giving full reasons for guidance, supported by detailed technical
reports; and
— in respect of the Periodic Review, establishing
and (with the agreement of Tube Lines and London Underground)
chairing a regular tripartite meeting to ensure adequate preparation
for the Review.
Annex 1
THE FUNCTIONS AND DUTIES OF THE PPP ARBITER
1. The role of the PPP Arbiter was established
by the Greater London Authority Act 1999 (GLA Act). Under the
terms of the GLA Act, the Arbiter is independent of Government
and of the PPP Parties and can only be dismissed by the Secretary
of State on grounds of incapacity or misbehaviour, or for unreasonable
delay in the discharge of his functions.
2. The Arbiter is a corporation sole. I was appointed
as the first Arbiter on 31 December 2002, and my appointment now
runs to 30 December 2010. I am supported by a small permanent
staff. As I am appointed as an individual, and am personally responsible
for the exercise of my statutory functions, I have also appointed
an Advisory Board to provide independent and expert challenge
to my decisions and procedures. Although I am not required by
statute to do so, I have published each year a Business Plan and
my Annual Report and Accounts setting out the work programme of
my Office and the resources used.
3. As PPP Arbiter, I have two principal
statutory functions:
— to give directions on matters specified
in the PPP Agreements, when asked to do so by one of the Parties
to a PPP Agreement; and
— to give guidance on any matter relating
to a PPP Agreement, when asked to do so by either (or both) of
the Parties to a PPP Agreement.
4. When the Arbiter is asked for guidance
by one Party only, the Act gives me discretion about whether to
give guidance. Where I am asked for directions, or am asked for
guidance by both Parties to an Agreement, I am required to give
directions or such guidance as I consider appropriate.
5. 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.
6. In addition, the Act gives the PPP Arbiter
further powers "for the purposes of the proper discharge
of the functions" conferred on him by the GLA Act. For example
the PPP Arbiter may do "all such things as he considers appropriate
for or in connection with the giving of a direction or guidance
and ... do such other things as he considers necessary or expedient
... for purposes preparatory or ancillary to the giving of directions
or guidance generally| notwithstanding that there is no matter
in relation to which a direction or guidance is required".
7. The PPP Arbiter's function in respect
of directions is limited by the terms of the PPP Agreements: if
there is no specific provision in a PPP Agreement for the PPP
Arbiter's involvement then disputes are dealt with through contractual
dispute resolution. Even on matters within his remit, he is only
brought in if one of the Parties seek a direction from him. The
PPP Arbiter therefore has no unilateral power to change, or propose
to change, provisions in the PPP Agreements. Even where he has
made a direction on a disputed matter within his remit, the Parties
may, under the provisions of the GLA Act, jointly agree to set
it aside.
8. In exercising his functions, the Arbiter
is under a statutory duty to act in the way he considers is best
calculated to achieve four objectives:
— to ensure that London Underground has
the opportunity to revise its requirements under the PPP Agreements
if the proper price exceeds the resources available;
— to promote efficiency and economy in
the provision, construction, renewal, or improvement and maintenance
of the railway infrastructure;
— to ensure that if a rate of return is
incorporated in a PPP Agreement, and taking into account matters
specified in the Agreement, a company which is efficient and economic
in its performance of the requirements in that PPP Agreement would
earn that return; and
— to enable the Infracos to plan the future
performance of the PPP Agreements with reasonable certainty.
The Arbiter is also under a duty to take account
of any factors which are notified to him by both Parties to an
Agreement, or are specified in the relevant PPP Agreement, as
ones to which he must have regard.
9. For the purposes of assessing costs at
a Periodic Review or Extraordinary Review, the PPP Agreement establishes
the concept of the Notional Infraco. This is defined as the 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.
September 2009
http://www.ppparbiter.org.uk/output/page21.asp?DocTypeID=5.
http://www.ppparbiter.org.uk/files/uploads/n_guidance/200611811558_Tube%20Lines'%20straddling%20reference.PDF.
http://www.ppparbiter.org.uk/files/uploads/f_articlesLectures/200741792822_CRI%20Occasional%20lecture.pdf.
1 HC45: The London Underground and the Public-Private
Partnership Agreements, Second Report Session 2007-08, 25 January
2008. Back
2
The Notional Infraco is defined in the PPP Agreement as the notional
entity with the same contractual terms and financing as Infraco,
and which carries out its activities in an "overall efficient
and economic manner and in accordance with Good Industry Practice".
The Notional Infraco is the basis of repricing the contract at
Periodic Review. Back
3
This "Materiality Threshold" was £200 million for
Tube Lines in the first Review Period. Back
4
London Underground has also indicated that it has no intention
of involving me in the Periodic Review of the agreements. Back
5
The Department for Transport: The failure of Metronet, HC 512
Session 2008-09, 5 June 2009. Back
6
Independent Reporter's Report on BCV's Annual Asset Management
Plan: Annual Report to the Arbiter and Independent Reporter's
Report on Metronet SSL's Annual Asset Management Plan: Annual
Report to the Arbiter, 17 July 2008 at Back
7
This issue was covered in guidance issued in 2006, following a
reference by Tube Lines: Reference for guidance by Tube Lines
Limited: Investment which straddles the Periodic Review, 8 November
2006 at Back
8
GLA Act, section 229(3)(b). Back
9
Regulating by contract and licence: the relationship between regulatory
form and its effectiveness, CRI Occasional Lecture, 28 March 2007
at Back
10
Under the provisions of section 230(2) of the GLA Act, I may
give guidance if the reference comes from one party; I shall
give guidance where both the Parties to an Agreement request
it. Back
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