Shaping the future of Britain’s railway

The implication is that change needs to happen - the report points out that there have been “many different management teams” trying to make NR (and before it Railtrack) work. Enforcement by the ORR (on 43 occasions) and “numerous internal reorganisations… suggest that management changes alone are not sufficient to resolve the planning and process issues on which industry is agreed”.

The report team plans to develop a range of options, from wholesale structural reform to smaller changes that could be slotted together in a variety of formulations. It asks what the most important structural features for any future infrastructure provider should be, how the relationship between the periodic review process and others could be improved, and what criteria should be used to assess structural options under consideration and how they should be prioritised.

The ORR determines NR’s revenue requirement for each Control Period, and this covers most of the company’s expenditure. However, some borrowing is required for enhancement projects. NR receives a direct government grant of £3.4bn, with train operators paying £2.4bn. 

Changes to the way NR is funded will affect the flow of money, and potentially the amount. If track access charges change, Shaw asks whether train operators should be “held harmless” from them in the future - a vital consideration if more money is channelled through them. 

At the core of NR’s funding is the Regulatory Asset Base (RAB) on which its borrowing was based. Shaw says that while the Government always had a role in funding the company, since NR’s reclassification in 2014 the whole of NR’s finances now “directly affect the Government’s fiscal objectives”.

Before reclassification NR could borrow against the RAB up to a limit of 75% of its value, giving it a degree of flexibility on enhancement projects. It now has a £30bn financing facility with the Government but a small buffer of £1.8bn, which has (according to Shaw) changed NR’s approach - from one focused on outputs and project delivery, to a system that focuses on level of expenditure and borrowing with a fixed limit on borrowing and a more limited risk buffer.

Since reclassification, Shaw argues that the purpose of the RAB is less clear as it no longer provides a risk buffer, and that the Government faces the whole cost of capital expenditure at the point it is spent. Against that, she says that the RAB is a well-understood regulatory concept to provide a guaranteed and stable return to investors (something that may be useful in the future), and that it focuses the company’s attention on financial responsibility. 

Should NR remain in the public sector, however, other methods may prove more transparent and accountable, says Shaw. She asks whether the RAB remains relevant - and if not what should replace it - and (crucially) how financial risk should be managed in Britain’s rail infrastructure.

The report outlines a range of potential funding options, from full privatisation to full public ownership and a range of possibilities between those two extremes (see diagram, right). 

The report team acknowledges that rules on public sector classification are complex and that certain funding options could have “diverse impacts” on public sector borrowing. It also adds that implementing certain options in a public sector setting could be challenging, because of rules and policies regarding the management of public funds.

Potential funding options include:

• Full or partial privatisation.
• Debt capital market issuance at the parent company level.
• Monetisation of non-core assets.
• Sale or other contractual arrangements on parts of the infrastructure.
• Part funding from local or devolved governments.
• Joint venture and other types of partnerships.
• Levies where businesses contribute to the cost of infrastructure.

Shaw says there are “significant pockets of demand for attractive infrastructure stories”, but warns that potential investors may need reassurance over long-term political support for the railway, robust cost estimate processes, greater visibility on the income stream over and above the Government’s support, a “tighter focus” on core activities, and a potential restructuring of the capital structure in support of a robust credit profile. 

Better alignment of incentives in the industry and “stretching yet realistic” regulatory targets may also be required. The report acknowledges that some projects will continue to require some government funding, but that this could take alternative forms such as grant funding through train operators. Where there is a clearer commercial benefit, one suggestion is that other organisations which benefit could be bought in to bear part of the cost. 

Shaw asks a range of questions on NR funding, asking how it should be achieved, and the types of investors who might be interested in investing in NR and their approaches. She also asks for examples in the wider rail sector and elsewhere of more affordable and sustainable funding and financing (with or without private sector capital input), what characteristics enhancements projects would need to attract private sector investment, and what ‘incentive mechanics’ or control structures on NR would draw in third-party involvement in financing enhancement projects.

Any changes to Network Rail’s structure and funding introduce a level of risk. Shaw acknowledges this, emphasising that any recommendations have to work from a whole systems perspective, “otherwise fixing an issue specific to NR may import risk into the wider railway system. In a safety-critical industry this point is key.”

She also argues that short-term and long-term risks need to be balanced, and that concern over the future creates uncertainty. She says there is a need to find the right balance between efficiency and flexibility, to adapt to new challenges but also optimise activities and operate efficiently.

It is impossible to draw conclusions from this scoping document - other than in the questions posed and the initial analysis, Shaw argues a compelling case that changes to NR need to be considered seriously and carefully.

Any move towards privatisation is likely to prove controversial - memories of Railtrack’s failure loom large. Equally, however, retaining NR in the public sector presents complex challenges in terms of accountability, funding and long-term planning. 

Shaw’s recommendations are due in early 2016, and could shape the future of Britain’s rail industry for a generation. They will need to be very carefully considered. 

• This feature was published in RAIL 790 on December 23 2015