Legal
With the re-launch of the franchising system and a return to shorter franchises, the spotlight returns to how operators and investors can be incentivised to invest on a long- term basis.Tammy Samuel looks at the options
R
ichard Brown and Sir Roy McNulty acknowledged in their reports that 'investment' is needed in the railway. But there does not appear to be widespread use of residual value mechanisms in the railway to incentivise train operators or investors to improve railway assets with a life beyond the end of a franchise. McNulty's partial response was to make franchises longer. With the recent re-launch of the franchising system, promised activity over the next eight years and a return to shorter franchises, the spotlight returns to how operators and investors can be incentivised to invest on a long-term basis.
In a railway franchising context, the residual or future value of the asset will be what the asset is worth at the end of the franchise in question. Without an acknowledgement, calculation or payment of this value, then an asset would have to pay for itself during a franchise period – something which could make the investment in question not worthwhile. This is obviously an issue for assets with a long-term life (e.g. rolling stock, stations and infrastructure) but can also impact on investment decisions in relation to assets with a medium or short- term life (e.g. ticket machines and gates).
Existing mechanisms
There are some existing mechanisms that support long-term investment in railway assets. In general terms, one way to incentivise investment beyond the end of the franchise is to ensure that there is a guaranteed value or guaranteed use for the asset after the end of a franchise. Another is to take an asset outside of the franchising system – allowing a return over a longer period of time. Each of the mechanisms below has some of the characteristics of each of these options.
Section 54 Undertakings A 'Section 54 Undertaking' given by the government – under section 54 of the Railways Act 1993 – is used primarily for rolling stock and is provided to owners of trains (mainly ROSCO's). The government undertakes that on a franchise change that someone will lease the rolling stock. These undertakings are given for
a particular period of time that allows the ROSCO to amortise the cost of the rolling stock, thereby providing certainty and reducing lease rentals for an operator. Section 54 Undertakings do not just have to be used for rolling stock – the power of the government in the Railways Act is very wide and could be used to support investment elsewhere on the railway, however these Undertakings are not given lightly and are seen as a contingent liability.
RAB funding Funding can also be granted through the Network Rail regulated asset base (known as RAB funding) – providing that once infrastructure is built, it will be adopted by Network Rail into its regulated asset base. Network Rail will then be entitled to make a return on the investment and charge that back to operators through access charges. To fund in this way, the ORR has to be convinced of the case for investment – and this can be a hard threshold to meet and it can be difficult to get RAB funding between periodic reviews. It is also useful for infrastructure investments alone, and not for other improvements that operators may wish to make.
Primary Franchise Assets The National Rail Franchise Terms (NRFT) contain some provisions which can be used to support investment beyond the term of a franchise. Designation of assets as primary franchise assets under the NRFT guarantees that those assets will be transferred from an outgoing to an incoming operator. However, unless there is an agreement to the contrary with the Department for Transport, the price to be paid for those assets is determined on a 'willing buyer, willing seller' basis on transfer. At that stage, there is only one buyer and one seller and very little bargaining power on both sides. It is also difficult to agree a market value at that stage since there will not be a free and open market for the asset in question. In designating an asset as a primary franchise asset, the DfT could also agree, upfront, the value that will be attributable to that asset on transfer which would provide some certainty - a rarely used mechanism.
There appear to be a number of approaches that could provide some certainty, with one or more formulae that could be utilised to agree an upfront value that would take away the uncertainty of a negotiated value on handover. Future value could be based on, for example, a straight line depreciation of asset cost, linked to a future profit or revenue from the asset, a 'look up' table in relation to most common assets or even perhaps a value linked to a future national passenger survey score improvement or other delivery target. Also in the NRFT, operators are encouraged to make proposals for investment that overhang the end of a franchise. The NRFT sets out what DfT will take into account when considering a proposal and some options that it may consider when looking at whether to approve a long-term investment – such as payback periods, ongoing payments after the end of the franchise and balloon payments which allocate a proportion of benefits into a future franchise. It is not clear is in what circumstances the DfT would use this mechanism, nor how values for any assets could be determined.
Other potentially useful mechanisms European law is supportive of investment in infrastructure and in rolling stock. The
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