Memorandum from the Department for Transport
(DfT) (UPP 07)
Q1. What lessons can be learned from the collapse
of the London Underground PPP Agreement with Metronet?
The collapse of Metronet was a major disappointment
for both farepayers and taxpayers. Some essential capacity enhancements
and improvements in maintenance, promised through the PPP contract
arrangements, will now be late in arriving on the ex-Metronet
lines.
There are many lessons to be learned from Metronet's
failure. But it would be wrong to conclude that one is that the
concept of the PPP itself is flawed. The National Audit Office's
June 2009 report "The failure of Metronet" was clear
that the main cause of Metronet's failure was poor corporate governance
and leadership rather than the PPP contract mechanism.
The interim Managing Director of London Underground
Ltd (LUL), Richard Parry confirmed at the London Assembly Transport
Committee on 3 September 2009 that Tube Lines has so far delivered
largely to time and budget. It has done so by managing higher
costs in some areas (stations) by securing efficiencies in others
(escalators). Tube Lines continue to work closely with LUL within
the contract structure to actively manage delivery challenges,
such as the upgrade of the Jubilee line. Where key deadlines or
outcomes fail to materialise, Tube Lines will bear the cost of
this through reductions in Infrastructure Service Charge. Despite
Metronet's failure, PPP contracts have the capacity to deliver
when parties engage constructively within the contract framework.
Furthermore, while the performance of Metronet
was clearly unacceptable, its failings should be considered against
the background of previous experiences of cost overruns and delivery
slippage on the London Underground. The Jubilee line extension
and Central line upgrade both presented the taxpayer with cost
overruns of 30% and were significantly behind schedule, some six
years in the case of the Central line upgrade. By comparison,
and using the NAO's own methodology, the cost to the taxpayer
generated by Metronet's failure lies somewhere in the range of
4-10% against the total value of the investment.
The Department remains committed to a process
of continuous review and improvement. Lessons learned from the
establishment and implementation of the PPP and other PFI contracts
have fed a continuous process of development in DfT and across
Whitehall.
Central standardised PFI contract terms are
now mandated for departmental use. This has enhanced and systematised
the rights of contracting bodies with regard to:
— changes in project documents and financial
arrangements;
— maintenance and access to contractor's
records—extending rights to access sub-contract details
and information provided to Senior Lenders; and
— managing contractor distress.
The application of these lessons to the recent
M25 Widening PFI translate into:
— a Secretary of State right to appoint
an observer to the DBFO Co (decision making) Board and therefore
has the ability to monitor the financial performance of the company
on an ongoing basis;
— the provision of an annual certificate
of compliance to the Secretary of State;
— a requirement for a detailed quality
management system for the whole supply chain;
— a mandatory value for money criteria
for all maintenance works (with any over £10 million requiring
a competitive tender);
— detailed record keeping based on open
book accounting principles;
— a specified range of events triggering
Expanded Interim Project Reporting (potential default, cost overruns,
distress indicators, profit warning, etc);
— a Secretary of State right to require
the DBFO Co to prepare and implement a Remedial Action Plan on
any area which he believes is inadequate, unsatisfactory or failing;
— payments are made to the DBFO co based
on the performance of the motorway. These payments increase as
key stages of the widening are delivered. Hence if the contractor
does not deliver according to the contract the payment is withheld;
and
— in addition, the absence of underpinning
of the debt financing by the Department during the construction
period means that the bank lending is fully at the lenders risk
for delivery failure.
Turning to the particulars of Metronet, it is
clear from the company's demise that one of the chief problems
facing interested parties—Metronet itself, shareholders,
lenders, LUL, the Arbiter and the Government—was the lack
of, or the poor quality of, information flowing between them.
This meant that the scale and nature of the problems confronting
Metronet became known too late in the day for effective remedial
action to be taken.
We are, therefore, taking steps to ensure that,
across the Underground investment programme, information on progress
of projects and economy and efficiency is available early enough
for problems to be picked up and addressed.
The National Audit Office report on the failure
of Metronet suggested that LUL should not have had to go to the
Arbiter to get hold of cost/performance information and that it
should have been able to request it directly from the infraco.
There will have been some commercially confidential information,
which it would not be appropriate for the infraco to share directly
with LUL—that is why the Arbiter is there as an impartial
source of expertise and guidance. Whilst under the Metronet contracts
it was for LUL to manage and request any information it thought
necessary, the option of asking the Arbiter for guidance on any
matter relating to the PPP agreement was always open to them.
It is, therefore, important that each party uses the information
that is freely available to them, including the DfT, so that each
party can manage the risk to which they are exposed.
The Arbiter, for example, is able to request
the infraco to provide any such information as he considers relevant
and in that sense the Arbiter does provide assurance on whether
the work performed is affordable and value for money and can work
with LUL and both parties in analysing the information. He is
able to use his powers to the full extent he considers appropriate,
such as conduct as detailed an investigation as he thinks appropriate.
With regard to the incentives in place for project
funders to ensure contract delivery, we review the approach for
each contract based on the nature of that agreement. It should
be noted that the circumstances prevailing at the time that the
PPP contracts were let meant that the provision of a significant
degree of underpinning to the lenders to Metronet was necessary.
Since the award of Metronet contracts, the Department
has not provided any similar guarantees to lenders on its PFI
contracts and has sought to ensure that the incentives on both
equity and debt providers are real and substantive in order to
support delivery of project objectives.
As part of the evaluation of PFI contracts,
the Department is considering the robustness of the corporate
governance arrangements for each contract in the context of the
particular contract. The nature of the PPP contracts—in
particular the Periodic and Extraordinary Review mechanisms—allowed
for significantly greater revisions to contract prices than exist
in standard PFI contracts. In the recently awarded M25 contract,
there was specific requirement for a detailed Governance Statement
that set out the role of the Special Purpose Vehicle and nature
of its decision making processes.
Q2. Are these lessons being applied to the
London Underground PPP Agreement with Tube Lines?
Tube Lines has so far delivered largely to time
and to budget and has had to find innovative ways to do so. For
example, while Tube Lines also incurred higher costs in delivering
their PPP station programme, they ultimately managed these pressures
using contingency funds and by finding offsetting efficiencies
in other areas.
Tube Lines greatest challenge to date has been the
delivery of the Jubilee Line Upgrade. Complex technical challenges
have obliged the company to revise delivery plans and timetables.
While disappointing—for LUL if the upgrade is delivered
late and at the cost of additional closures, and for the company
who face significant abatements to ISC payments—these challenges
are now being addressed. Tube Lines are also confident that the
lessons now being learned will realise benefits when signalling
upgrades on the Northern Line and the Piccadilly line are delivered.
While real delivery challenges remain, therefore, the Department's
view is that the PPP agreement with Tube Lines is working in the
manner envisaged.
Although the DfT is not party to the PPP Contract
between LUL and Tube Lines, with large amounts of government money
being invested Ministers and Officials will continue to meet regularly
with LUL, Tube Lines and the Office of the PPP Arbiter to monitor
progress.
We are also taking steps to ensure that the
Review for 2010-17 runs as smoothly as possible and that (within
the bounds of propriety and commercial confidentiality, and in
view of the fact we are not a party to the agreement) we are kept
fully informed by both parties as to developments. The Arbiter
set out his proposed timetable for receiving and responding to
a reference on cost, and any further references on financing.
We indicated to the parties that we considered this a sensible
timetable and encouraged the parties to move to an early reference
to ensure clarity on costs in good time for the start of Period
2, to minimise cost to LUL and disruption to passengers. We are
therefore pleased that a reference has been made at an early stage
(23 September). Our liaison with the parties is geared to identifying
and understanding where the risks to the taxpayer may be and doing
as much as we can (within the constraints of the devolution framework
for London, and without being a party ourselves) to ensure these
are effectively managed by the contracting and other interested
parties.
In the context of the second period review,
the Department acknowledges the recommendation in the NAO Report
that the Arbiter should be able to highlight issues affecting
the taxpayer's interest. We have, therefore asked both Tube Lines
and LUL to consider how the Arbiter's role can be strengthened
and improved to protect the wider public interests. These changes
might include increasing the Arbiter's rights to undertake reviews
of PPP programme delivery, economy or efficiency without formal
reference by one of the contracting parties. Such changes must,
however, as the NAO Report recognises, be agreed by the parties
themselves and cannot be applied retrospectively by Government.
Q3. How has the upgrade work progressed since
the demise of Metronet?
Since the TSC Inquiry into the PPP Agreements
in the autumn of 2007 there has been a considerable progress on
line upgrade programmes.
It is LUL's and TfL's responsibility to ensure that
the former Metronet upgrade programme is delivered to time and
budget and that they meet the outcomes in terms of increased passenger
capacity and reduced journey time that were specified in the original
PPP Contracts.
Examples of progress so far include:
— The TfL run Metronet BCV business is
progressing the Victoria line upgrade, which has seen the first
new train enter passenger service on 21 July 2009 during limited
late night operations in order to grow system reliability. In
parallel the new automatic train control and signalling system
is being installed.
— The TfL run Metronet SSL business has
seen new trains with air conditioning being tested at the Old
Dalby test track facility during the summer in order to grow system
reliability of the train interface with the upgraded signalling
system. The first train is due to be tested on the Metropolitan
line in December 2009 with the first train expected to enter passenger
service in May 2010. Signalling upgrade works on the Metropolitan
line is progressing to schedule.
Metronet's failure to deliver its station programme
has meant that LUL has had to recast the programme and scope of
the work and we look to LUL to ensure that this revised programme
is delivered in a timely and cost effective manner. Nevertheless
work on 124 stations has now been completed, which is a further
33 since the TSC Inquiry of autumn 2007 meaning that 48% of the
total has now been completed.
Delivering the upgrades is only part of the
story. For passengers using the tube on a daily basis having a
reliable journey is key. Perhaps the most important indication
on the improved performance of the Network is the availability
indicator as recorded in "Lost Customer Hours", which
has been published in "London Underground PPP & Performance
Report 2008-09" on the TfL website at http://www.tfl.gov.uk/corporate/modesoftransport/londonunderground/management/1582.aspx.
By comparing previous reports we can see that there have been
some substantial improvements since Metronet administration and
since the PPP commenced as indicated in the table below:
PPP company/line
| 2003-04 | 2004-05
| 2005-06 | 2006-07
| 2007-08 | 2008-09
|
| Lost Customer Hours against benchmark
| | | |
| |
| Tube Lines | |
| | | |
|
| Jubilee | 33% worse | 1% better
| 8% better | 20% better | 0%
| 9% worse |
| Northern | 32% worse | 95% worse
| 62% worse | 23% worse | 25% worse
| 31% better |
| Piccadilly | 8% better | 52% better
| 63% better | 51% better |
49% better | 54% better |
Metronet SSL |
| | | |
| |
| Metropolitan, Circle, Hammersmith & City
| 21% better | 50% better |
39% better | 37% better | 44% better
| 48% better |
| District | 43% better | 35% better
| 16% better | 19% worse | 53% worse
| 14% better |
| East London | 4% better | 2% better
| 34% better | 29% better |
20% better | Line closed |
Metronet BCV | |
| | |
| |
| Bakerloo | 15% better | 34% better
| 13% better | 10.7% worse |
3% better | 34% better |
| Central | 16% worse | 2% better
| 14% better | 24% better |
33% worse | 33% better |
| Victoria | 16% worse | 9% worse
| 11% worse | 26.7% worse |
40% worse | 23% better |
| Waterloo & City | 58% worse
| 12% worse | 66% worse | 29.2% worse
| 66% worse | 219% worse |
| |
| | | |
|
For 2008-09 the Jubilee line is just below benchmark for
the reasons explained above in the problems encountered in the
delivery of the signalling upgrade, but all other lines are performing
well above benchmark with the exception of the Waterloo &
City line, which was due to train defects and signalling issues
causing train cancellations. LUL are addressing this with a "hit
squad" and already seen substantial improvements so far in
2009-10. One of the most significant improvements can be seen
on the Northern line where Tube Lines has spent much of the first
period making the infrastructure more reliable, through track
replacement and improving the signalling. For the former Metronet
lines we can see that for many their performance dipped during
the lead up (2006-07) and period in administration (2007-08) as
Metronet's problems crystallised.
Tube Lines are now close to completing the Jubilee line upgrade.
The project has presented real delivery challenges and the need
for additional closures has been disappointing. We are aware that
it has been frustrating for LUL. We have received reassurances
from Tube Lines that lessons learned from this project will be
applied to upgrades of both the Northern and Piccadilly lines.
We look to both parties to agree to innovative solutions to minimise
inconvenience to the public in the future.
Q4. What contractual arrangements are appropriate for the
future?
A Joint Steering Committee consisting of LUL, TfL, DfT and
HMT was tasked with considering a range of options for the permanent
structure of the Metronet contracts, with the objective of:
— providing a stable and safe operational framework
for the Tube;
— delivering the modernisation, upgrade and maintenance
of the Tube infrastructure;
— delivering Value for Money for the taxpayer.
The Joint Steering Committee has now reported and the Mayor
and Secretary of State have accepted its recommendation that the
existing Metronet contracts should remain under the direct control
of LUL on a permanent basis. LUL will remain responsible for all
asset management decisions, but there will continue to be substantial
private sector involvement with much of the work carried out through
contracts managed by LUL. In detail:
— Existing contracts for the Victoria line upgrade (signalling
and rolling stock) and for the Sub-Surface line upgrade (rolling
stock) will continue—these contracts were inherited from
Metronet (and have been varied).
— A new contract will be awarded for the Sub-Surface
line signalling upgrade—an Invitation to Tender was issued
this summer.
— The Bakerloo line upgrade is not due to start until
2020. A decision on the most appropriate contracting arrangement
will be taken nearer the time, reflecting lessons learnt from
both the Jubilee and the Victoria line upgrades.
— Track renewal and civil engineering work (bridges,
tunnels, embankments etc) will be carried out through direct procurement
with the appropriate form of contract.
— For station refurbishment, LUL will award a new framework
contract based on a detailed client specification—offering
a degree of risk transfer whilst retaining budgetary control at
LUL.
— LUL will retain safety critical maintenance and inspections,
among other things, with other line maintenance and station cleaning/facilities
management carried out via bundled service contracts.
In awarding new contracts, LUL will include robust performance
incentives and transfer risk where appropriate.
The JSC rejected the option of new long-term performance
based contracts for the Victoria and Sub-Surface line upgrades
as prohibitively expensive. In both cases major contracts for
elements of the upgrades are already underway and would either
need to be unpicked at great cost of time and money, or passed
on to a new delivery partner, limiting their flexibility to innovate
and achieve efficiencies and again resulting in a high risk premium.
This is not the case for the Bakerloo line upgrade which is still
some years off. A long-term performance based contract may therefore
be more appropriate for the Bakerloo line upgrade.
The JSC concluded that longer term value for money will turn
on LUL's ability to deliver on time and within budget. LUL has
not had direct responsibility for upgrades of this magnitude since
the PPP began, and will need to build its capability if it is
to improve on its pre-PPP record and deliver major upgrade projects
successfully. The Mayor and Secretary of State are considering
the most appropriate way to scrutinise the delivery of the ex-Metronet
(and other) works in order to protect the public interest.
Q5. What risks, if any, are associated with the PPP Agreement
with Tube Lines?
The Government is fully aware that the involvement of the
private sector cannot always guarantee success, nor that it will
deliver innovation, efficiency and economy. However there are
also examples when the public sector management of major projects,
including LUL in the 1990s, has also been unsuccessful. It is
clear that there is no single procurement model or formula for
success in delivering major and complex projects, and the appropriate
structure must be adopted in each case.
As noted by the PPP Arbiter's evidence at the TSC in 2007, the
private sector can successfully deliver projects when there are
clear outcomes specified in the contract and the company is free
to decide the approach that it should take to deliver those outcomes.
Tube Lines to date has had reasonable success working to the same
contract that was applied to Metronet, though with different materiality
thresholds, ie the point at which an Extraordinary Review can
be triggered with the Arbiter to give a direction on costs.
It is clear that the private sector will continue to be the
major force in delivering improvements to the London Underground,
whether the contracting mechanism is through the intermediary
of the PPP agreement with Tube Lines, or direct with LUL now that
they have taken over the contracts with private suppliers that
were once Metronet's.
Under the permanent structure which replaces the Metronet
PPPs, LUL intends to continue public reporting of performance
and will maintain the PPP performance measures to provide a basis
for performance assessment and comparison with Tube Lines. Moreover,
LUL undertakes that it and (to the extent practicable) its sub-contractors
will make available to the statutory PPP Arbiter such level of
information as he requests and requires to assess the performance
of Tube Lines.
Part of the Secretary of State and Mayors' consideration
of any new arrangements will be the extent that scrutiny applies
across TfL's investment programme, including management of the
former Metronet business, other private sector contracts and those
elements of the investment programme delivered in-house (such
as some types of maintenance).
Q6. What impact is the current economic situation having
on transport PPP and PFI schemes and what are the financial implications
for other transport schemes?
The most relevant aspects of the economic situation for transport
are falls in passenger numbers and the deterioration of the financial
markets. It is also worth considering any potential decline in
market interest in PPP schemes.
Fall in passenger numbers: The majority of transport PPP
schemes do not include volume risk (ie payment is on delivery
of services rather than linked to passenger numbers) and therefore
the fall in passenger numbers observed across transport modes
is not adversely affecting the performance of PPP deals which
are already signed. This is true for the Tube Lines PPP scheme
where the charges to LUL are based on infrastructure maintenance
and delivery of upgrades.
In a few transportation PPPs, such as the M6 Toll and Second
Severn River Crossing, traffic risk has been passed to the private
sector to manage. We are not aware of any transport PPPs in which
the drop in passenger linked revenues is having sufficient impact
to destabilise the concession.
Deterioration in financial markets: The deterioration
in financial markets has led to much tighter credit conditions
and significantly more expensive funding terms. For PPP projects
which have already closed, however, there is minimal impact.
New transport PPP projects have managed to raise finance
and close since the downturn, notably the M80 in [February], the
M25 upgrade in May (which raised £1 billion from EIB and
commercial banks) and the Carlisle Northern Development Route
in July. Generally however progress to financial close has been
slower and final costs have reflected higher funding terms. The
higher financing costs have been partially offset by the reduction
in underlying interest rates and no transport schemes have been
cancelled due to unaffordability or inadequate value for money.
A notable result of the recent financial upheaval has been
the withdrawal of the capital (bond) markets from the infrastructure
arena and a reduction in the number of banks prepared to commit
large sums to long term loans. This has meant that whilst smaller
deals can get done with relative ease, larger deals (£500
million plus) have required a combination of EIB and/or strong
sponsor support.
Market appetite: There is no evidence that the current
economic conditions are having an adverse affect on market appetite
for bidding for transport PPP schemes. For construction companies
and operators, PPPs represent attractive opportunities in relatively
quiet markets. This has been most recently demonstrated by the
strong bidding field for the Sheffield Highways Maintenance scheme
(with a capital value of over £500 million) which came to
the market this summer. There equally does not appear to be a
constraint in attracting the equity required to support the financing
of PPPs. Over £200 million of contractor equity was raised
for the M25 and strong equity bids have been received on the current
Inter-city Express Programme and Thameslink rolling stock procurements.
Q7. What role has Government played in these matters?
Government has worked closely with TfL and LUL during the
period of Metronet administration to expedite the smooth transfer
out of administration of the Metronet companies and above all
to ensure the continued safe operation of the tube. The process
has also included engagement with the European Commission who
needed to consider whether the restructuring (when Metronet's
businesses were transferred to two TfL nominee companies in May
2008) was in compliance with our Treaty obligations. This was
a critical step in putting the tube back on a stable footing while
work to agree a permanent restructuring continued.
Over the course of 2008, DfT and HM Treasury, supported by Partnerships
UK, worked with TfL and LUL to consider the full range of options
for Metronet's permanent structure. Recommendations were then
made to the Mayor and Secretary of State who have now accepted
that the contracts should continue to be managed directly by LUL
on a permanent basis—subject to compliance with our Treaty
obligations in respect of state aid. The Government will continue
with its discussions with the Commission accordingly.
Alongside this the Mayor and Secretary of State will be considering
ways of improving efficiency, effectiveness and economy in the
delivery of TfL's obligations under the former Metronet and ancillary
contracts.
We have also considered the future role of the Arbiter who,
under the PPP arrangements, will continue to have a pivotal role
in driving Tube Lines towards being economic and efficient. While
it is of course for London Underground and Tube Lines as contracting
parties to manage the Periodic Review process to a successful
outcome, DfT has been liaising with all parties to ensure that
the process runs as smoothly as possible.
Department for Transport
October 2009
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