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The ROSCOs will be toast as IEP becomes a 35 year deal
According to the businessman and philanthropist John Templeton, the four most dangerous words are ‘It's different this time'. Sir John's adage came instantly to mind when DfT Rail unveiled its approach to procuring the Intercity Express Programme (IEP). After a decade of emulating other forms of private transport, where operating leases are standard, DfT Rail is going to give the Private Finance Initiative ( PFI ) another whirl.
This seems perverse for a number of reasons. Above all, a key issue in the Department's current complaint against the Rolling Stock Companies over the lease rentals on the ex-British Rail fleets has been lack of transparency.
With the ROSCOs, the buzzword is ‘un-bundling'. DfT Rail wants the lease rentals to be broken down into their component parts so that it can see where the taxpayer is being short-changed. It also wants to see more competition for rolling stock at franchise renewal time when rolling stock leases are also renegotiated.
But, with IEP, potentially the biggest traction and rolling stock order for years, DfT Rail is proposing to bundle everything together in a train service provision package lasting 30-35 years. Sounds familiar? Yes it's a revival of the original PFI -type deal to provide new trains for the Northern Line signed back in April 1995.
Worth ‘over £500 million' at 1995 prices and funded by the then Bank of Scotland and Forward Trust, the 20 year Northern Line PFI included performance related maintenance payments of £40-45 million a year. As I write Alstom, the funders and Tubelines, which inherited the contract from London Underground, have been trying to un-bundle the deal for over a year.
Of course, it's different this time – for a start the acconyms and abbreviations are better. Figure 1 shows how it will work.
First of all you need a Train Service Provider ( TSP ). In another blast from the past this may be set up as a Special Purpose Vehicle (SPV).
As we all know SPVs are an ingenious way of bringing private sector capital into the railway. We also know that while several have set off down the runway none, save Adrian Shooter's Evergreen II, has managed to lift its nosewheel off the tarmac, yet alone achieve a positive rate of climb.
Yes, I know, it's different this time. The expectation is that within an SPV the TSP will bundle together equity and debt funding to buy the trains and build new depots, a train manufacturer, a maintenance provider and depot provision.
Alstom, Bombardier, Siemens, plus Hitachi to come, are all running depots as part of train service provision deals. The Northern Line excepted, these are all linked to franchises and the trains are owned by ROSCOs.
But what DfT Rail expects is that one or more finance houses will sign up with a train manufacture. The resulting TSP will bid for the IEP deal.
Already Babcock & Brown has signed up with Siemens and we can expect a series of beauty contests as finance houses and manufacturers get together. Given the timescale, speed dating could be a more apt description.
Note that there is no role for the ROSCOs in this approach, although their owning banks might be up for it. Note, too the possible unintended consequence, where the best train has an inferior finance package and an outstandingly average combination emerges the winner.
However, this possibility is half covered. Although debt and equity must be integral to the consortium at the Invitation to Tender stage ‘to ensure bids are bankable and best value', DfT Rail will reserve the right to hold a debt funding competition where consortia ‘do not demonstrate best value'.
So if they like your train but not its finance, the funding may have to be ‘re-competed'. But hang on, at Megabank you've spent millions setting up this SPV and now DfT Rail want to hand the lucrative bit over to another bank? We'd better call our lawyers.
Oh all right then, DfT Rail says that it will ‘tolerate' ‘a pre-defined right to match' for the incumbent funders but for no more than, say, 50% of the funding requirement, mind. Equity will not be re-competed.
Anyway, DfT Rail, the Secretary of State (SoS) in fig 1, will sign a 30-35 contract with the successful TSP through the Master Availability & Reliability Agreement (MARA). This will be some contract, because it will have to be staged to cover the pre-series batch, fleets for the Great Western and East Coast and then, possibly more trains for other routes. It will also have to allow for technical development over the next 10-15 years and obsolescence over 30-35. Tom Winsor will be in his element.
While DfT Rail has the MARA, the payment to the TSP over the 35 years will be laundered through the train operators. Each franchise with an IEP fleet will have a separate Train Availability & Reliability Agreement (TARA) with the TSP . This will run for the life of the franchise, nominally 10 years.
So the new paradigm is long term asset finance based on a 30-35 year payment stream. Unlike leasing, the financial backers within the SPV will know that the asset will be earning a predetermined return throughout its book life. Oddly one of the specific IEP risks identified by DfT Rail is the possibility of the TSP retaining some residual value risk.
But despite the assured employment of the trains, there will still be technical and other risks. Covering these over three decades or more is likely to be expensive. But note in Fig 2 that DfT says that the TSP will not carry the risk of reconfiguration and redeployment.
Also excluded from the SPV's responsibility is the upgraded infrastructure on which IEP is crucially dependent. DfT Rail will take the risk of procuring the ‘base specification' infrastructure from Network Rail on the routes operated
This is not an academic issue. Suppose the TSP designs the trains for promised standards of billiard table smooth top and line but the track turns out to be a bit bumpier than the promised. The higher shock forces mean that bits start falling of your lightweight bogies and the TARA and MARA go to pot. Just send the bill to the SoS.
Clearly, as it tries to drum up interest, DfT Rail is concerned not to frighten potential SPV funders. It emphasises that there will be no third party revenue risk and that the project will be ‘near' to the government revenue stream. And in general risk allocation will follow PFI precedent, whatever that means.
Significant government support is promised, although with the caveat that ‘options are still to be resolved'. But DfT Rail claims that the risk allocation and payment mechanism will be ‘bankable'. For example the TARA , which brings in the money, being signed with the TOCs, it will be ‘underpinned' by government, ie the taxpayer. .
What if a TOC runs out of cash or is terminated by government with extreme prejudice and can't make its TARA payments? Fear not, long term comfort will be provided by Section 30 of the Railways Act 1993 which places a statutory obligation on the Secretary of State to ensure continuity of passenger services. And you can't do that without paying for the trains.
And should Megabank need even more security, Section 54 of the Act allows the Secretary of State to give undertakings regarding future franchises and asset usage. Actually that might be a comfort too far. DfT Rail admits that policy on the application of Section 54 to IEP ‘is still under development'.
With expressions of interest closing on 18 June, there isn't long to set up an SPV. While there seems to be no way in for the ROSCOs, they will probably try to pre-qualify anyway.
A key question is whether manufacturers will be monogamous in a sellers market. With 10 days to go, DfT Rail reported that only five ‘major' train manufacturers but over 35 financial institutions had registered an interest. Will there be enough credible potential suppliers in this game of musical banks?
At the industry day, which DfT Rail held to sell IEP, one brave soul raised the possibility of a future government wanting to change the speciciation. DfT Permanent Secretary Sir David Rowlands replied ‘To quote Margaret Thatcher, there is no alternative'. ‘Why would politicians ever want to disagree with this output specification' he asked, adding ‘before long it will too late to go down a different road'.
Given that Sr David Steps down an the end of May, I'm sure everyone found that very comforting. Once upon a time there seemed to be no alternative to the Advanced Passenger Train.