Response from the Office of the
Rail Regulator
This memorandum is the official response of the Rail
Regulator to the Transport Committee's report of 1 April 2004
on the future of the railway.
It takes the form of the points made by the Committee
- which are reproduced
in italics -and the Regulator's response.
We have seen no evidence, since our predecessors
reported two years ago, that fragmentation in the rail industry
has reduced. Indeed, our evidence has suggested that it is
getting worse. In addition, industry costs are increasing; performance
remains in the doldrums; and the SRA appears utterly incapable
of managing significant improvements. The evidence of the Rail
Regulator's Interim Review of track access charges is that the
Regulator and the SRA are not co-operating well. [Paragraph 7]
1. The Committee appears to equate a fragmented industry
with a fractured one. This is not a fair description of the railway
industry. Many industries operate well on the supply chain model,
with separate entities concentrating on what they do well and
with well-designed and competently operated interfaces. The reforms
of the industry's contractual regime which ORR has put in place
since 1999 repair the faults of the 1994-97 privatisation in this
respect, and Network Rail and train operators are now co-operating
in a true joint venture which recognises the intensity of their
interdependence.
2. Following the access charges review 2003, infrastructure
costs are now firmly under control, and coming down. A £5
bn a year railway will be a £3.5 bn a year one
in 2009, with 31% efficiency improvements in control period 3
(2004-09). The Committee has failed to recognise the facts.
3. Performance of the infrastructure is improving
strongly, and train operator performance is following suit. Network
Rail is on course not only to meet the performance targets for
the current years which the Regulator set in ACR 2003, but it
is likely to beat them.
4. The Regulator and the SRA have disagreements from
time to time. It would be unusual if they agreed on everything
all the time. Their respective jurisdictions are clear and have
always been respected by the ORR. The Regulator explained some
of the difficulties which have arisen in paragraphs 56-60 of his
formal submission to the DfT rail review.[5]
[In a quotation from Dr Dieter
Helm:] ... the
Rail Regulator and the SRA have a concordat which cements [a material]
confusion of roles between them. [Paragraph 8]
5. In law there is no confusion in the roles of the
Regulator and the SRA. Under the legislation establishing the
Rail Regulator (Railways Act 1993) and the SRA (Transport Act
2000), Parliament has given specific functions to the Rail Regulator
and different ones to the SRA.
6. This principle was underscored by the concordat
of 25 February 2002 between the Rail Regulator and the SRA. It
stated that:
a) "The Strategic Rail Authority (SRA) and
the Office of the Rail Regulator (ORR) have common statutory
purposes and different powers by which those purposes are
to be achieved." (emphasis added)
b) "[The two organisations commit themselves
to] promoting clarity over their roles and responsibilities, recognising
their separate. discrete and complementary jurisdictions
and statutory duties and the absence of regulatory overlap
or competition". (emphasis added)
7. The concordat was welcomed and endorsed by the
Secretary of State when it was announced.[6]
Its effect has been endorsed several times since.[7]
The separate jurisdictions and the need to avoid duplication are
expressly underscored in the Secretary of State's directions and
guidance to the SRA.[8]
8. The Secretary of State, other Ministers and the
Chairman and Chief Executive of the SRA have therefore publicly
confirmed that there is no overlap, conflict or competition between
ORR and SRA. There is none.
9. Far from "cementing confusion", the
concordat dispels it, for those who are willing to understand
it.
The SRA and the Rail Regulator were left [by Government
policy failure] with overlapping duties and powers which later
led to a struggle to determine which of them ran the railway.
In addition, the Rail Regulator is independent of the Government
in regulating Network Rail but is also under a duty to "have
regard" to the budget of the SRA in setting Network Rail's
funding levels. He must also have regard to guidance from the
Secretary of State, a policy stressed in the Government's 1998
White Paper. It is no wonder that in a recent publication explaining
the difficulties of reconciling these and other duties he said
that "the Regulator's duties do not always point in the same
direction and may conflict". The Government appears to have
assumed that the Regulator's duty to have regard to guidance would
ensure that the Regulator considered the financial needs of the
railway in the overriding context of Government and SRA policy
and budgets. This has not happened. [Paragraph 12]
10. For the reasons given above, there is no overlap
of powers. The statutory duties of the two bodies have deliberately
been placed in harmony by Parliament, so that the two organisations
are trying to achieve the same things. Alignment of statutory
objectives is a good thing, not a bad thing, as the Committee
appears to believe.
11. There has been no struggle about which of the
Regulator or the SRA "runs the railway". Neither does.
The railway companies run the railway, and they should. Because
of the public interest in the competent and efficient operation
of the railway, the companies in question are regulated under
the authority of Parliament. The infrastructure provider (Network
Rail) is regulated by the Regulator under statute and licence.
The franchised passenger train operators are regulated under statute,
licence and contract by the SRA. Regulation is not about running
the businesses within the jurisdiction of the regulatory authority.
It is about ensuring a sound and efficient framework for operations
consistent with and which promote the public interest. The Committee
displays a fundamental misunderstanding of what public interest
regulation is for and how it works.
12. Conflicts between individual statutory duties
are hardly surprising in individual cases. That is why the law
provides a coherent and rational regime for the resolution of
such conflicts when they arise. They happen in all economic regulatory
models, and the courts have little difficulty in dealing with
such situations. See for example the judgment of the High Court
in R -v- Director General of Telecommunications exparte Cellcom
Ltd [1999] ECC 314, where it was held that a regulator is
"given the choice how [a conflict between his statutory duties]
is to be resolved and to decide priorities, and so long as he
bears in mind the entirety of his duties so far as this is practicable
and with those duties in mind makes a decision which promotes
one or other of the objectives specified (and is rational) his
decision stands and is not open to challenge".
13. The statutory duty to have regard to guidance
from the Secretary of State is just that. Guidance is guidance;
it is not a set of orders.
14. On 26 September2002, the Secretary of State issued
guidance to the Rail Regulator under section 4(5)(a), Railways
Act 1993. It asked the Rail Regulator to work closely with the
SRA in the access charges review and to "share information
[with the SRA] at an early stage on anything that may be material
to forward financial planning by the SRA". Recognising that
the Rail Regulator may make a decision which would cause the SRA
to incur expenditure beyond its allocated budget, the guidance
asked him first to "discuss [the matter] with the SRA and
allow it to make representations [to him]. In doing so, [the Rail
Regulator was also asked to] allow the SRA the opportunity to
consider whether it would wish to amend its strategies or seek
consent from the Secretary of State for additional expenditure".[9]
Throughout the access charges review, the Regulator implemented
both the letter and the spirit of the statutory guidance.
15. Similarly, the Regulator is required to have
regard to the financial position of the SRA. That requires the
Regulator to know what the financial position of the SRA is. As
explained in the Regulator's supplementary evidence to the Committee
(dated 26 March 2004), paragraphs 15-18, despite several requests
the Regulator was never informed of the full extent of the SRA's
financial position.
16. In assuming that either of these two duties is
an overriding one, the Committee is mistaken in law. Neither is.
There is nothing overriding about them. The Regulator has one
overriding statutory duty, and that is in the specific context
of the construction of the Channel Tunnel Rail Link under the
Channel Tunnel Rail Link Act 1996.
However the Government chooses to reverse the
present position of the railway, it will be essential that
in future it ensures proper control over the money it provides.
…The Government has the responsibility to sort out the current
mess; it needs to make sure that it has the powers required to
do so, and that the powers and responsibilities of all the bodies
involved in the railway industry are appropriately structured.
[Paragraph 18]
17. For the reasons given below, the Government already
has all the power it needs in relation to the future financing
of the railway. It only requires the will to use it.
18. If there is any change to the jurisdiction of
the ORR in this respect, it will have to be brought about by legislation.
Such a step would be a clear breach of the formal assurances which
the Secretary of State gave to Parliament and the financial community
on 9 February 2004, which is why the Government should not and
will not do it.
It is unfortunate that the Regulator
has chosen not to reply to our letter of 10 December 2003. [Paragraph
28]
19. The Regulator replied in full to the Committee's
letter. The reply was sent on 28 March 2004 with a full explanation
of the delay provided to the Committee on 29 March 2004.
Mr Winsor's…..
regime has [not been] successful
in ensuring that the infrastructure operator has complete knowledge
of its assets. [Paragraph 29] Network Rail has now indicated that
'a baseline asset register providing an inventory of the assets
and their key attributes' will not be ready until mid-2005. [Paragraph
30]
20. Network Rail's asset register is well on the
way to completion, under regulatory scrutiny. It is on schedule,
and the Regulator is surprised that the Committee is dissatisfied
with progress.
The Regulator has clearly failed to ensure that
Railtrack and now Network Rail have produced information needed
to assess performance of the system. If the state of the infrastructure
is not thoroughly known then reliable decisions about the levels
of maintenance and renewals are simply not possible and the basis
of the Regulator's Interim Review is placed in doubt. This episode
demonstrates graphically how the Regulator has failed in his core
function of effectively regulating the "stewardship of the
national rail network". [Paragraph 31]
21. There has been no such failure, as the Committee
well knows.
22. During its period of stewardship of the national
network (1994-2001), Railtrack had inadequate knowledge of its
assets and what it took to maintain and renew them. This was startlingly
apparent as the first post-privatisation access charges review
(begun in 1999 and which ended in October2000) got underway. ORR
had to cope with desperately poor quality information from Railtrack,
and took every possible step to improve that information as the
access charges review went along. However, the information deficit
was so great that it was quickly realised that it would take several
years to put it right. ORR had to make its decision in October
2000 on the best information available at the time.
23. For this reason, as part of the access charges
review 2000 ORR determined that it was essential that Railtrack's
accountability for the money it received in access charges (and
compensating grants) be significantly improved, including by a
legal obligation to establish a register of the capacity, capability
and condition of its assets. A new network licence condition -
Condition 24 - was devised and retrofitted into the company's
network licence. This was done in the expectation that, when the
next access charges review took place in 2005-06, the necessary
information about the company's assets would be far better. Condition
24 recognised the poor state of the company's asset knowledge
at the time and provided for phased improvements, under the supervision
of the regulatory authority, over several years. This was the
fastest the work could be done given the state of Railtrack's
asset knowledge at the time.
24. Moreover, reforms to Network Rail's network licence
(the principal instrument of its public interest accountability)
have been secured by ORR so as significantly to strengthen Network
Rail's delivery of its public interest and network-wide responsibilities
in areas such as:
a) its stewardship of the network, through its
business planning process, in obligations to maintain, renew,
replace, improve, enhance and develop the network in accordance
with best practice and in a timely, efficient and economical manner
so as to meet the reasonable requirements of train operators and
funders in respect of the quality and capability of the network;
b) the imposition of controls on Network Rail's
ability to dispose of land which is - or
may be - needed for railway
purposes;
c) the appointment of independent regulatory
reporters who examine and assess the competence and efficiency
of Network Rail's operations and report to the Rail Regulator
on compliance with its network licence obligations, the company's
annual stewardship report to the ORR, and the need for remedial
or enforcement action;
d) corporate governance and reporting on its
financial affairs; and
e) dealings with dependent users and potential
users of the network, and the providers of finance for services
relating to railways, requiring the company to behave with efficiency
and economy, skill, diligence, prudence and foresight.
25. These new licence conditions are already having
significant beneficial effects on the way in which the company
is managed and performs.
The Regulator clearly failed to achieve [investment
in capacity to satisfy the demands of growth in passenger and
freight traffic at the time it is needed] when Railtrack, a private
company with shareholders, was the infrastructure provider. It
is not clear that he has been any more successful in the new structure.
[Paragraph 32]
26. Given the chronic nature of the problems of the
infrastructure provider stored up by Railtrack in the years 1994-99,
and brought to a head in October 2000 when the Hatfield derailment
occurred, the focus of regulatory action since 1999 has been on
the operation, maintenance and renewal of the network, not its
enhancement (with the principal exception of the West Coast upgrade).
27. If the Committee has any criticism of the nature
and effectiveness of regulation between 1993 and 1998, it should
ask its questions of the Regulator at the time.
28. Through the 2003 access charges review, Network
Rail is now equipped with a stable and reliable financial settlement
for the competent and efficient operation, maintenance, renewal
and enhancement of the network.
Mr Winsor's defence of regulation…does not
take full account of the SRA 's role as a significant industry
'customer' whose requirements may conflict with those of the Regulator.
Nor does it take account of the fact that although the infrastructure
provider is technically a private company, it has no shareholders
and its debt funding is effectively guaranteed by the Government.
[Paragraph 35]
29. The SRA is an extremely important funder of the
railway, and as such is the principal beneficiary of Condition
7 of Network Rail's network licence. That is why the Regulator
involved the SRA so heavily and closely in the 2003 access charges
review. Far from having conflicting requirements from the SRA,
the Regulator took every possible step to ascertain the SRA's
requirements and to inform it and the Government of the consequences
of the continuation of the existing pattern of services.
30. There have been two access charges reviews since
Railtrack was privatised in 1996. The first concluded in October
2000; the second ended in December 2003. In both cases, government
could have acted early to secure a result which would not have
led to the increases in access charges which in fact came about.
But its engagement would have had to have been much greater. In
the first access charges review (1999-2000), the degree of engagement
by the SSRA (as the agent of government) was not strong, and the
regulatory authority was compelled to conclude that broadly the
existing pattern of services should be rolled forward, with some
improvements in performance. Access charges were set accordingly
and Railtrack became entitled to a 50% increase in its
income.
31. In the second access charges review (2002-03),
things did not go according to plan either. Whilst the SRA, the
Department for Transport and the Treasury were much more closely
involved with the regulatory authority, and had access on a continuing
basis to a very large amount of information about the emerging
picture as the 15-month review proceeded -which showed
by how much the revenues of Network Rail would have to rise to
maintain the existing pattern of services -
they failed to take the necessary avoiding
action which could have led to much lower levels of access charges
and compensating grants.
32. Before beginning the 2002-03 access charges review,
in September 2002 the regulatory authority asked government if
it was certain that a full access charges review was what it wanted,
with the consequence that access charges may have to rise substantially.
The alternative of a simple, non-statutory regulatory assessment
of the efficient costs of the provision of infrastructure services
was available. Government indicated that a full access charges
review was desired; indeed nothing less would have been sufficient
if Railtrack were to be taken out of administration. And so the
regulatory authority proceeded with the 2002-03 access charges
review.
33. On 26 September 2002, the Secretary of State
issued guidance to the Rail Regulator under section 4(5)(a), Railways
Act 1993. It asked the Rail Regulator to work closely with the
SRA in the access charges review and to "share information
[with the SRA] at an early stage on anything that may be material
to forward financial planning by the SRA". Recognising that
the Rail Regulator may make a decision which would cause the SRA
to incur expenditure beyond its allocated budget, the guidance
asked him first to "discuss [the matter] with the SRA and
allow it to make representations [to him]. In doing so, [the Rail
Regulator was also asked to] allow the SRA the opportunity to
consider whether it would wish to amend its strategies or seek
consent from the Secretary of State for additional expenditure".[10]
Throughout the access charges review, the Regulator implemented
both the letter and the spirit of the statutory guidance.
34. In February 2003, the Rail Regulator informed
government that if access charges were not to rise substantially
at the end of the review (to be announced in December 2003 and
take effect from 1 April 2004), the SRA should then (early 2003)
be making material changes to its franchising and other strategies
to impute lower (and therefore cheaper) network outputs. It would
have done this by:
a) not entering into new franchises for service
patterns which implied network outputs as high as the existing
levels;
b) renegotiating existing franchises so as to
lower implied network outputs;
c) exercising rights under existing franchises
to lower passenger service requirements; and
d) negotiating compensation for freight operators
to persuade them to lower their network output demands of Network
Rail, and with Network Rail to agree to those lower outputs.
35. The SRA did not do these things, possibly because
government did not want it to. They would probably have meant
cuts in the intensity and geographical reach of existing services,
no new services, no new enhancement, severe reductions in the
amount of renewal to be done with consequent higher numbers of
temporary speed restrictions and poorer performance, and passenger
fare rises well above inflation.
36. Government and others have to face the fact that,
under the existing system, it is not possible to have 100% of
the existing service pattern and the infrastructure which is necessary
to support it for 50% of their efficient cost.
37. In July 2003, the regulatory authority asked
government what changes to the SRA's strategies were to be made
in the light of the regulatory authority's emerging conclusions
in the access charges review. The effective answer given was that
the regulatory authority should assume that the existing pattern
of services would continue and be rolled forward. It was on that
basis that the decision in the 2003 access charges review was
taken. It is therefore not correct to say that the regulatory
authority decided what the pattern of services should be or, in
setting network outputs, went against what government intended.
Full account of government's settled intentions was taken.[11]
38. In acting as it did, government by default accepted
that its subsidy to the railway would have to rise substantially.
If it had cut back on the pattern of SRA-supported services and
the intensity of the demands which those services would make of
the network, government would have faced a much lower bill. But,
as explained above, this would have required government to face
the political consequences of severe cuts.
It is the Government, not the Rail Regulator,
which guarantees private investment in the railway. [Paragraph
36]
39. The Committee misunderstands what is meant by
guarantee in this context. Of course the regulatory system does
not undertake to meet the financial obligations of the railway
if it fails to meet them itself. That appears to be the sense
in which the Committee uses the term, although it is not clear.
What independent economic regulation does is assure private investors
that the infrastructure provider will be fairly and properly funded
for the competent and efficient operation, maintenance and renewal
of the network, and will not be required to get a quart out of
a pint pot.
40. On 20 January 2004, the Organisation for Economic
Co-operation and Development published its report on the UK economy.
In the section about the railway industry, and Network Rail in
particular as a company without shareholders, it said:
"An important function of the Regulator is to
ensure that private investors receive a reasonable rate of return
provided that the [infrastructure provider] company behaves in
an efficient manner. The independence of the Regulator is important
in reassuring the private sector that it will not be subject to
arbitrary political interference, thereby encouraging private
investment. Without shareholders, it is hard for the Regulator
to discipline a company that simply passes bills onto passengers
or the Treasury. Hopes of leveraging in large amounts of private
capital have been greatly diminished by recent events, as the
framework is too vulnerable to political interference. If the
Government hopes to raise substantial amounts of money from the
private sector, it needs to be clear as to how this can be achieved
in the current setting. On the other hand, the case for an independent
Regulator that sets the outputs expected for a given level of
funding, and protects legitimate third party interests, is even
stronger. The Government should clearly define the lines of responsibility
and reinforce and ensure the Regulator's independence."
41. The Regulator respectfully agrees with the OECD
and disagrees with the Committee.
The Regulator, Network Rail and the SRA clearly
differ about who exactly runs the railway infrastructure in the
UK Although we understand the need for a measure of regulation
to prevent a monopoly company abusing its position, the Regulator
is not the customer, and should not specify what the customer
is buying. It seems that the Regulator cannot do the job of economic
regulation without effectively acting as the informed customer.
This is to confuse the roles of economic regulation with the SRA
job of purchasing services. In those circumstances, it is clear
that the railway structure must be fundamentally changed. [Paragraph
41]
42. As to the issue of who runs the railway, see
above.
43. For the reasons given above, the Regulator does
not specify what the customer is buying. There is therefore no
confusion of roles. Accordingly there is no case for fundamental
change in structure for this reason.
Mr Winsor failed to square [the position of the
Regulator as a quasi-arbitrator of what the network requires]
with his other clear responsibility to "have regard to the
budget of the SRA".[Paragraph 45]
44. The lengths to which the Regulator went to have
regard to the financial position of the SRA are described above.
They were considerable.
Our inquiry exposed an astonishing and fundamental
disagreement between the Government and the Regulator about the
extent of the latter's powers. According to the Minister, the
Government had a choice about whether to accept the Regulator's
access charges settlement; but the Regulator considered that the
Government had no option but to accept his decision. This is a
prime example of the confusion which lie at the heart of the present
structure of the railway and why it is essential that this
structure must be streamlined. Since we took this evidence, the
Secretary of State has made clear, in answer to a parliamentary
question, that the Government is committed to the Regulator's
access charges settlement. We were pleased to note that in the
same answer the Secretary of State indicated that the Government
would need to consider "whether options for changes to the
industry structure might imply consequential changes to the details
of economic regulation".[Paragraph 48]
45. The Minister's evidence to the Committee on 5
November 2003 was incorrect. In view of the Secretary of State's
statement to Parliament on 15 December 2003, in which he made
it abundantly plain that the Government is committed to honouring
the private law contracts of industry which it has entered into,
and the letter from the Permanent Secretary at the Department
for Transport dated 16 December 2003, it is abundantly plain that
the evidence which the Regulator gave to the Committee is supported
in full by the Government. Indeed it was the erroneous evidence
of the Minister in November 2003 which led to the necessity of
the Secretary of State and the Permanent Secretary putting the
record straight. In making its remark about confusion, the Committee
appears to have ignored or misunderstood the 15 and 16 December
2003 statements.
46. Accordingly there is no confusion.
47. The statement about consequential changes is
about just that. It is not about fundamental change. So, for example,
if the SRA is abolished or its role radically altered and more
is done by the DfT, there will be a necessity for changes to the
"details" of economic regulation which are "consequential"
on that abolition.
It appears that both the Government and the SRA
were unprepared for the result of the Rail Regulator's Interim
Review of track access charges and that a last minute panic took
place about how the financial implications of the Regulator's
settlement for the SRA were to be met. The SRA and the Government
should not have been surprised that the Regulator was proposing
to set aside his duty to have regard to the SRA's budget because
Mr Winsor said so specifically in his Draft Conclusions document
published in October 2003. The Regulator chose not to give appropriate
weight to his statutory duty by ignoring the SRA 's budget; and
the Government and the SRA failed to challenge this decision.
[Paragraph 49]
48. The Government and the SRA could not have been
taken by surprise, since the Regulator's conclusions were trailed
and the direction in which they were going was disclosed to the
Government and the SRA months in advance.
49. The Regulator gave proper weight to his statutory
duty in relation to the financial position of the SRA, as explained
above.
50. The Government and the SRA failed to challenge
the Regulator's decision because there were no grounds on which
either of them could do so. Indeed, in his statement to Parliament
on 15 December 2003, the Secretary of State welcomed the Regulator's
decision.[12] The Committee
knew that. It is irrational to criticise a failure on the part
of the Government to challenge a decision which it has itself
welcomed.
This whole episode is not only an example of the
high handed manner in which the Regulator approaches his role;
it is an example of a deep failure in the structure of rail governance
which has allowed the Regulator to act as a "Rail Czar",
something that was never intended and which must be corrected.
[Paragraph 50]
51. The Regulator's approach to the access charges
review and the rest of the role cannot be characterised as high-handed,
especially not on the basis of assertions of the Committee which
have no basis in fact.
52. The Regulator has strictly adhered to his statutory
remit and has neither strayed from it nor neglected it. However,
the scheme of access charges reviews requires all parties to play
their full parts, including government.
53. Calling the Regulator a 'rail czar' is not a
serious criticism. It may play well with sub-editors, but it is
hardly a mature contribution to the debate. Indeed, the Regulator
has himself criticised such notions in his Sir Robert Reid Memorial
Lecture 2004, of which the Committee has copies.
The private sector needs appropriate protection
from arbitrary Government decisions. But the current power of
the Regulator goes far beyond reasonable bounds and must be reined
back The enormous sums of public money directed to the railways
by the Regulator are ones over which, astonishingly, neither the
Government, not the SRA, have any practical control. The Government
has little choice but to honour the cheques which the Regulator
writes for it. [Paragraph 51]
54. The current power of the Regulator is the power
invested in him by Parliament. It is a power shared by other economic
regulators.
55. The jurisdiction to carry out an access
charges review comes from the contracts between the franchised
passenger train operators and Network Rail; it is not conferred
by the legislation. The jurisdiction is conferred on the Rail
Regulator. By contrast, the procedure for an access charges
review is in Schedule 4A, Railways Act 1993. That procedure allows
for an appeal by Network Rail against the Rail Regulator's decision.
The right of appeal is to the Competition Commission.
56. If access charges rise as a result of an access
charges review, franchised passenger train operators have to pay
those higher charges to Network Rail. This is unremarkable. It
is what happens when the price of goods or services are increased
according to an established external process, and is found in
other areas of economic activity in capitalist systems.
57. The Committee's objections appear to centre on
the fact that franchised passenger train operators have the benefit
of an indemnity from the state against rises in access charges
arising from an access charges review by the Regulator. The effect
of the indemnities is that any such increase in access charges
- although payable to Network Rail by the train operators - flows
through to the state. This is sometimes characterised as the Rail
Regulator "writing cheques on the Treasury's account",
and, as such, offensive to democratic principles. This is a misconception.
58. The indemnities are contained in the franchise
agreements between the franchised passenger train operators and
the Strategic Rail Authority. The indemnities - unlimited in amount
and lasting for the life of the contracts - are not provided for
by legislation. Nor are they required by the law, by the Rail
Regulator or any other agency. They are private law contracts
freely entered into by the agency of a sovereign government. Government
has the choice - and has always had the choice - of not indemnifying
train operators. It would require no change to legislation for
the policy and practice of indemnification to be discontinued
for the future. Government can do this whenever it likes.[13]
59. It is therefore inappropriate to blame the regulatory
regime for the existence of these indemnities. If government regrets
the fact that its agent is bound by these contracts of indemnity,
it can now - without
legislation - and should
do something about it. All it requires is an act of will, not
an Act of Parliament. The proper course of action would be both
to stop signing any more indemnities and to buy out the existing
ones. An improper course of action would be to legislate to restrict
the scope of existing indemnities. Indeed to do so would not only
be a breach of the Secretary of State's assurances to Parliament
in December 2003 and February 2004, it would also constitute an
unlawful abrogation of private property rights contrary to the
European Convention on Human Rights and a violation of the sanctity
of contract. The harm which would be done to the Government's
standing and reputation with business, in particular with the
City of London, would be considerable.[14]
60. Moreover, when people complain that the regulatory
authority is unelected and so should not have the effective power
to determine how much public subsidy goes into the railway industry,
they miss at least two important points.
61. First, the regulatory authority is performing
a quasi-arbitral role under a private law contract. It is required
by the terms of that contract to determine how much a competent
and efficient network operator needs for the core job of operating,
maintaining and renewing the network in the light of its contractual
and regulatory obligations, including those established in accordance
with government policy. As explained above, once made, that determination
may cause access charges to rise and train operators to have to
pay more to Network Rail. They in turn will require the agent
of the state - the SRA - to honour its contracts of indemnity.
If the SRA fails to pay under the indemnity, the train operators
will have a private law action for recovery of a debt due. This
is the ordinary operation of the law of contract. Yet commentators
and others appear to believe that somehow the railway is different,
and that the ordinary law of contract should not apply to railways
in the way in which it applies in every other field of economic
and private activity. Their thesis appears to be that government
- merely because it is government - should be bound by its contracts
only for as long as it suits it, and when it does not, it should
be free to disregard those commitments without redress. The proposition
has only to be stated to be dismissed. Government is bound by
its obligations just as much as others. Were it not so, the word
of government would be worthless and people would simply not do
business with it.
62. As for the objection that the regulatory authority
is unelected, it should be noted that if the train operators were
to enforce their rights under their indemnities, that enforcement
would be delivered by judges. Judges are not elected either. The
proposition that all institutions which wield considerable power
should be elected or controlled by those who are would, if implemented,
effect a fundamental and deleterious shift in the constitutional
balance of the UK.[15]
This is not conducive to private investment in the provision of
public services.
63. Second, the regulatory authority does not have
a free hand to determine the size and quality of the network,
and so the amount of public subsidy going in. It never did. This
is a common mistake and has led to criticisms of the present system
which are misconceived.
64. In assessing the financial requirements of the
infrastructure provider and then setting access charges (or offsetting
grants), the regulatory authority must assess what are the reasonable
requirements of Network Rail's customers and funders, its obligations
under its access contracts and the commitments it is likely to
make.[16] The regulatory
authority then sets access charges (or offsetting grants) accordingly.
To make that judgment about reasonable requirements, the regulatory
authority of course needs to know what they are. This is where
the system has broken down in the past.
65. Franchised passenger train operators have access
contracts, usually of five or seven years' duration. Some are
longer. Freight train operators have similar lengths of contract.
Together these contracts provide for the extent and intensity
of usage by train operators of the national network belonging
to Network Rail. There are other open access operators, but not
many. They too have contracts. And there are Passenger Transport
Executives and some other funders who also put money into the
railway and buy services. None of these commitments is perpetual.
All must end some time, but there is an expectation that they
will be replaced by something. The vast majority of these services
are subsidised in one way or another. The demands which operators
make of the network - and so the intensity of use contemplated
by, and the geographical reach of, access contracts - are a function
of the demands of their customers. In the passenger railway, the
principal driver of these demands is government through its agent,
the SRA, in setting its franchising policy. It follows that government
decision is the major determinant of the use and reach of the
network.
66. In setting the network outputs which Network
Rail is required to deliver in the next control period, the regulatory
authority has to make a judgment as to what will be the pattern
of services - the extent and intensity of use - of and on the
network in that period and beyond. The most important factor which
the regulatory authority has to take into account is the settled
intention of the Government and its agency - the SRA -
for the franchising and subsidising of services
in the future. The regulatory authority needs to know what those
services are likely to be. When it has that information, it can
then translate that expected and projected service pattern into
network outputs for Network Rail to deliver, apply the appropriate
efficiency assumptions, and set access charges accordingly.
67. It is for government to ensure that its agent,
the Strategic Rail Authority, or the Department for Transport
acting in its own right, engages - and
is allowed to engage- in
the planning of railway services in sufficient detail and in sufficient
time to ensure that the regulatory authority has the information
it needs to translate a service pattern decided by government
- together with other contractual rights - into a set of network
outputs which government is content it can afford without doing
unnecessary damage to its other priorities. This may well require
five- and ten-year planning horizons for government. Once made,
they should be adhered to. That is what transport planning needs
anyway, and the present system works to encourage or even corral
government into doing it. But the present system cannot compel
government to do it.
68. By playing its part in this way, government has
the right effectively to decide to scale back on the quality and
performance of the network by devising long-term policies and
plans which contemplate a decline in the infrastructure but which
will not violate the rights of third parties. It can do this by
coming up with a franchising and freight subsidy strategy which
would lead to this result. Those decisions by government are likely
to be the determinative ones, although if there are other funders
willing to pay for infrastructure to support services which government
is not willing to subsidise, their rights are protected by the
regulatory authority and their interests will be protected. But
if there are no other paying customers for higher network outputs,
the regulatory authority is not entitled to insist that
higher outputs are provided.
69. It is for government to decide how it wishes
to spend its money. Overall and in the long-term, all government
expenditure on the railway is discretionary. But once it has made
that decision and entered into binding commitments in that respect
- i.e. through franchises or other contracts - it has exercised
its discretion and the expenditure has become non-discretionary.
Government must honour the commitments it makes. And it must make
them in a timely way.
70. It is of course perfectly lawful for government
to make binding commitments -franchise agreements and associated
instruments - which last for only a year or two, perhaps three,
at a time.[17] This would
allow government to sculpt its expenditure obligations to its
political priorities and change them from time to time in the
short-term. Such an approach would mean that the railway industry
would return to almost the annualised financial regime it had
under nationalisation with the attendant harm to private investment,
lack of confidence, stability, predictability and the opportunity
to make reliable and sustainable plans,[18]
but it could be done.
71. Equally, it would be inimical to private sector
confidence if the contracts government makes were to provide for
a unilateral right of government to turn down the quality or extent
of the network on which train operators and their backers rely,[19]
unless there were secure provision for the payment of adequate
compensation. Even then, it is likely that private sector businesses
would be more reluctant to invest in new rolling stock if they
face the risk of a politically-imposed slow decline in the quality
of the infrastructure on which they must run, for fear of the
difficulties, delays and expense of securing adequate financial
compensation for the effects on their businesses of that decline.
Government does not need this right to act mid-term in the life
of a contract. It has all the power it needs to make its plans
before franchises and other contracts are let, and to communicate
those decisions to the regulatory authority in good time and then
allow the system to set the network outputs and the charges accordingly.
The present situation is an intolerable restriction
on the Government. The sums of money decided by the Rail Regulator
are so large, and the issues for the transport infrastructure
of the country so important, that the Government needs to take
back from the Regulator decisions over the level of infrastructure
funding. [Paragraph 52]
72. For the reasons given above, the Committee is
criticising a system which does not exist.
…[I]t is arguable that the accountability
of Network Rail is less than Railtrack which had shareholders.
... The actions of the Rail Regulator to strengthen the terms
of Network Rail's network licence may be welcome in themselves,
but are no substitute for sound day to day management and powerful
managerial accountability to the owner. [Paragraph 61]
73. It is unarguable that Network Rail's accountability
is less than that of a company limited by shares. Of course it
is less. It is striking that the Committee now criticises a corporate
structure which it so warmly welcomed when the Government set
it up. In his evidence to the Committee in November 2001, the
Regulator pointed this out to the Committee. He welcomes the fact
that the Committee has understood him.
[Present levels of performance are] scandalous,
and demonstrate [...] the utter inability of the industry as presently
structured to improve its performance. [Paragraph 64]
74. Performance levels are improving strongly. The
industry has a strong ability and will to improve performance,
and it is doing so. The Committee is operating on misconceptions
as to the facts.
It appears most unlikely that the targets for
reducing delays set by the Rail Regulator for Network Rail will
be met fully, if at all. ...
For the Regulator to place
ever more challenging targets on a structure which is incapable
of meeting them fully is nonsensical. [Paragraph 69]
75. As explained above, the regulatory targets for
Network Rail in respect of reductions in train delays are on course
to be met and indeed beaten. There is nothing nonsensical about
setting targets which lead to improvements in performance, and
the Committee should expect the regulatory authority to continue
to do so, despite the Committee's opposition.
[The arrangements under which the Chairman and
the Chief Executive of Network Rail can lose their jobs if they
breach certain financial targets] is an example of the Rail Regulator
"dressing up" Government financial support as a regulatory
"incentive" to defend the present regulatory regime.
[Paragraph 72]
76. Loss of livelihood usually incentivises people
to try to avoid it. In view of the pedigree of some members of
the Committee, the Regulator would have expected the Committee
to understand this.
[The Rail Regulator's addition of £11 billion
to Network Rail's regulatory asset base to ensure that Network
Rail was not handicapped by the overspending of Railtrack and
because the SRA agreed to compensate Network Rail for the company's
overspending up to April 2004] demonstrates the extent of the
power which the present structure has allowed the Regulator to
accumulate at the expense of all the other parts of the railway,
and of the Government. The Regulator is meant to be restraining
costs and seeking value for money. Instead, the present structure
has permitted him to write off astonishingly large sums of public
money, apparently on his own authority. One highly significant
aspect of the overspending during the period in which Railtrack
was in administration is that, in the middle of the most severe
crisis for the industry in the last 10 years, the SRA, which must
have been backed by the Government, bypassed the Regulator. The
system was not flexible enough for all parties to join together
in finding the best solution in extreme circumstances. [Paragraph
79]
77. The Regulator has the powers to adjust the regulatory
asset base conferred on him by and with the authority of Parliament.
The Committee is wrong to characterise the Regulator as having
accumulated powers, as if by stealth.
78. All economic regulators have the power to set
and adjust the regulatory asset base of the companies in their
jurisdictions. The Committee appears to be surprised about this,
even though it is a system which has operated since 1984 in numerous
price reviews in all the privatised network industries.
79. The additions to the regulatory asset base were
fully explained to the Committee and the legal basis for doing
so is sound. The Committee should not express surprise at a system
on which it has received detailed evidence from the Regulator
on the occasions of the 2000 and 2003 access charges reviews.
80. On 9 January 2004 the Regulator asked to be called
back to the Committee to explain his final conclusions in the
2003 access charges review. The Committee refused that request.
Evidently it should have accepted it.
We are concerned that the drive to reduce costs
appears in conflict with long term investment in the infrastructure.
Balancing costs and investment needs to be undertaken on the basis
of solid data and agreed targets, both of which appear to be in
short supply. [Paragraph 105]
81. The Regulator has explicitly taken the long-term
sustainable view of the efficient costs of the operation, maintenance,
renewal and enhancement of the infrastructure. This has been explained
in considerable detail in his papers and conclusions in the 2003
access charges review.
82. See above in relation to the quality of data.
The Regulator was entitled to challenge Network
Rail's estimates of work required where these appeared to him
to be in excess of necessity. We are nevertheless astonished at
the spectacle of two bodies - Network Rail and the Rail Regulator
- in dispute in this manner. This is not an outside body (the
Regulator) undertaking a straightforward check of the operator's
documentation, but appearing to undertake a root and branch parallel
exercise by consultants in renewals' estimation. Either the renewals
documentation of Network Rail is grossly deficient - as the Rail
Regulator appears to believe - or the Regulator undertook too
detailed an examination, at a considerable consultancy cost. [Paragraph
106]
83. The Committee appears fundamentally to misunderstand
what economic regulation is about. It is not just about "checking
the operator's documentation". An economic regulator is not
an auditor sent in to sample the books. An access charges review
- a price review in other industries - is a thorough assessment
of what a competent and efficient infrastructure provider will
require for the discharge of its public interest and commercial
obligations.
84. The thoroughness of the 2003 access charges review
was made plain in the documentation published in the review. It
appears that the Committee has not had a sufficient opportunity
to examine it.
It was inefficient and highly expensive for Network
Rail and the Rail Regulator to undertake parallel exercises assessing
renewals' requirements of the rail infrastructure. It should be
a firm objective for the future economic regulatory authority
and the infrastructure provider to ensure that the quality of
the latter's estimation processes and records is sufficient to
provide a very high degree of confidence in what is being proposed,
allowing there to be much less parallel checking and micro-management
in future. [Paragraph 107]
85. In the 2003 access charges review, there was
considerable use of common consultants and data. The Committee
has based its criticisms on factually incorrect assumptions.
In circumstances [in which Network Rail's estimates
of its funding requirements varied by over £2.5 billion from
those of the Rail Regulator], it is difficult to understand why
the company has now agreed to a settlement which its own estimated
figure appears to suggest is too low for the work it considers
necessary without complaint. It had options to ask the Regulator
either to issue a new review notice, or refer his determination
to the Competition Commission, but chose not to do so. This suggests
that the company's estimates of funding requirements cannot be
relied upon. [Paragraph 109]
86. The company has agreed to the regulatory settlement
in the 2003 access charges review because it is right.
87. That is why the company did not ask for a fresh
review notice or appeal to the Competition Commission.
…[T]he Rail Regulator specifically rejected
the SRA's request to lower the budget for Network Rail maintenance
and renewals expenditure on the basis of anticipated savings arising
from [its] strategy [of differentiated maintenance], considering
that the extent of the savings was uncertain. ... The
Rail Regulator's refusal to adjust Network Rail's expenditure
to take account of the SRA 's Specification of Network Outputs
is an excellent indication of how severe the limitations on any
SRA strategy in the present structure of the industry when it
affects the operation and budget of the infrastructure provider,
which are effectively specified by the Regulator. [Paragraph 145]
88. Under Condition 7 of Network Rail's network licence,
the Regulator is required to assess what are the reasonable requirements
of customers and funders. It is not for any particular customer
or funder to insist on its own interpretation of what its reasonable
requirements are. That is a function given to the Regulator by
Parliament.
The SRA has a role as a chief customer for railway
enhancements. However, as we have seen, its discretion is fettered
by the ability of the Rail Regulator to specify Network Rail's
outputs in some detail. One example of this confusion is the West
Coast Main Line upgrade project where the SRA has sought to exert
control but does not have the power to do so. [Paragraph 153]
89. See above in relation to the role of the SRA
in disclosing its franchising strategy to the Regulator.
[In respect of the West Coast main line upgrade,
the Regulator] was not working to the SRA's strategy. [Paragraph
157]
90. The Regulator's duty under section 4(1)(za),
Railways Act 1993 is to exercise his functions in "the manner
which he considers best calculated to ... facilitate the furtherance
by the Authority of any strategies which it has formulated with
respect to its purposes". That is not the same as "working
to the SRA's strategy", which the Committee appears to think
means doing what the SRA says.
We are deeply concerned by the nature of the decision
making process revealed by the recent events on the West Coast
Main Line upgrade project. Even now there appears to be no agreement
on the entirety of the project. Neither the SRA, the Rail Regulator
or Network Rail seems to have the power to make a final decision.
The Government seems powerless to intervene. It is hard to think
of a more telling example of the divided leadership of the railway
and the powerlessness of the SRA. [Paragraph 160]
91. The Regulator establishes the network outputs
as part of his determination of the reasonable requirements of
customers and funders under Condition 7 of Network Rail's network
licence.
92. The system is clear and rational. The SRA may
not have the powers which the Committee would like it to have.
The Regulator cannot help that, since legislation is a matter
for Parliament, not him.
93. If the Government secures the agreement of Parliament
to change the jurisdiction of ORR in this respect and takes powers
to itself or another entity to set network outputs, it will break
the 9 February 2004 assurances made to Parliament.
It is clear to us that the SRA does not have the
powers and responsibilities to provide it with the commanding
position of leadership that the industry requires, and to drive
through the improvement in rail operating performance which the
Government and the travelling public are entitled to expect. [Paragraph
182]
94. The SRA is not supposed to be a commander. It
is a franchising authority, the procurement arm of government.
If Parliament had intended the SRA to be more than it is, it would
have made it so.
The current railway structure blurs responsibility
for policy and railway services and is not fit for purpose. Rail
policy can never be divorced from decisions about overall public
expenditure which are the responsibility of Government. The Government's
function of adjudicating on the public interest has been passed
to the Regulator who acts as a "proxy for the public interest".
The Government is presently compelled to carry out his funding
decisions; Network Rail is required to carry forward and manage
the operational consequences of his financial planning; the SRA
has struggled to determine railway outputs because the Regulator
has effective control over the infrastructure. In addition, however
well advised, the Regulator is ultimately not professionally equipped
to take detailed operational and managerial decisions about the
railway. Our evidence has shown in detail how this present rail
structure, far from focussing the various parts of the railway
as a whole on improving services to the passenger, has meant that
valuable energy has been diverted to intra-industry squabbling
and "buck-passing", while co-operative moves by the
various rail bodies governing the industry have had little or
no demonstrable effect upon improving performance. [Paragraph
211]
95. There is no blurred responsibility for policy.
The position is quite clear. How people react to that fact is
a separate matter, but it cannot alter the disposition of power
determined by Parliament.
96. For the reasons given above, the Government has
and always has had not only the responsibility but also the power
to set overall subsidy levels for the railway industry. It has
not always used that power.
97. The determination of the public interest in the
context of railways has been established by Parliament in section
4 of the Railways Act 1993. How that applies in individual cases
is not, of course, something which Parliament could rule upon.
It has properly determined that the Regulator should operate strictly
within that policy context, and that is what the Regulator does.
98. The Government must always be expected to honour
its contracts, including its contracts of indemnity. See above.
99. The Regulator cannot be criticised if others
are dissatisfied with the jurisdiction conferred upon him by and
with the authority of Parliament. They must answer for how they
have reacted to the exercise of the Regulator's statutory discretions.
If they had grounds for challenge, they would have used them.
100. As explained above, the industry is improving
performance markedly.
A model of railway governance is required which
restores to the Government control over the public interest, public
expenditure, rail policy, and objective setting; while allowing
the railway industry full operational responsibility for the delivery
of improved infrastructure, train service outputs and strategy
objectives. [Paragraph 212]
101. There is no need to restore something which
was never lost.
One of the most negative aspects of the present
railway governance arrangements is the Rail Regulator's autonomy
and its undermining of the SRA 's strategic role. [Paragraph 213]
102. The importance of the independence of the Regulator
has been stated and underscored by the Government and others -
such as the OECD - many times. That is why the Secretary of State
has committed to preserving it and why the 9 February 2004 assurances
made that so plain.
103. The Regulator's autonomy undermines no-one's
role. It is, as the Secretary of State said in his statement to
Parliament on 12 June 2002, an "essential continuing requirement".
104. If the Committee is so opposed to independence
in economic regulation, it is puzzling why a majority of its members
voted for what is now the Railways and Transport Safety Act 2003
without any attempt to alter that independent status.
[T]he success of the present regulatory regime
in fundamental aspects of controlling costs laying down strong
incentives, providing for secure knowledge of the industry's assets,
quantifying investment arising from it, and working well with
other railway bodies under Government guidance, has been abysmally
poor. It did nothing to prevent the appalling debacle of Railtrack
when the railway came close to collapse. The costs of the industry
have still to be brought under control. In addition, as we have
demonstrated, it is the Government and not the Rail Regulator
which guarantees the railway and the private investment. Finally,
the Regulator appears to have extended his role in setting track
access charges into the forward management of Network Rail's business
- something that was surely never envisaged to be part of his
function - thus subverting the proper function of that management
and risking a further confusion of roles. [Paragraph 214]
105. The Committee appears to ignore the facts. Cost
control, incentive regulation and asset knowledge are all fundamental
parts of modern independent economic regulation. The Regulator
has secured real and substantial improvements in all these respects,
and they are already generating real and substantial benefits
in infrastructure-caused delays to trains and the efficiency and
costs of the industry. These are strong successes, and it is simply
wrong to characterise them as the Committee does.
106. The Regulator works very well with other railway
bodies.
107. The chronic problems of Railtrack were not of
the Regulator's making. Rather, from 1999 he has vigorously pursued
an agenda - now complete - of improving the accountability
of the infrastructure provider to its customers and the public
interest.
108. The costs of the infrastructure provider are
under control. They have been brought under control by the 2003
access charges review. They went out of control because of the
Hatfield derailment and the decision of government to apply to
the High Court for a railway administration order in respect of
Railtrack.
109. The Regulator has not extended his role. He
has discharged his statutory remit to the letter.
In 1998, the Environment, Transport and Regional
Affairs Committee, reviewing the prospect for a new Strategic
Rail Authority, and the potential for entanglement with the responsibilities
of the Rail Regulator, expressed its concern. ... It
... considered that "restoring the original requirement
in section 4 of the Railways Act 1993 for the Regulator to take
into account guidance by the Secretary of State" would provide
an adequate safeguard. That requirement was restored by the Transport
Act 2000 which includes a provision for the Secretary of State
to give the Regulator guidance, but, as we have shown in this
inquiry, this appears to have been ineffective. [Paragraph 216]
110. The Committee appears to misunderstand the nature
of statutory guidance.
We consider that there may be some continuing
role for independent regulation of the railway to ensure that
contractual obligations are met, that access is properly controlled,
and to perform a speedy arbitration function in the event of contractual
disputes. However, we think that the Government in its present
review of the railway structure needs to cut back severely the
present, highly interventionist, regulatory regime. In particular.
we consider that it is completely inappropriate for the Regulator
to determine alone the funding which the Government must set aside
for the railway infrastructure, given the size of the sums concerned
and the knock-on effect on other areas of public expenditure.
The planned move to a regulatory board structure with the same
functions as the Regulator later this year does not, in our view,
affect this argument. [Paragraph 217]
111. It is not the proper role of an economic regulator
to enforce contracts or arbitrate commercial disputes. The Committee
appears to misunderstand the nature of economic regulation.
112. The present regulatory regime is not highly
interventionist. The policy of the Regulator has been to empower
the infrastructure provider and the infrastructure user in their
relationship, and to create a true joint venture between them.
He has succeeded in that. There is nothing interventionist about
a system which brings provider and customer closer together, with
alignment of interests, and allows the regulatory authority to
step back on the stage, although not off it.
113. For the reasons given above, the Regulator does
not determine alone the funding of the railway. The Committee
criticises a system which does not exist.
Office of the Rail Regulator
4 July 2004
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