4.7 Franchises could fail for two reasons: firstly, because of problems specific to the train operator or its parent, or secondly, because they are unable to cope with a prolonged downturn in the economy, which affects adversely passenger demand.
4.8 On the specific risks faced by individual franchises, the Department has improved its monitoring of the financial performance and business risks of train operators and of parent companies. The franchise agreements require operators to supply it regularly with more detailed and forward looking financial information, including business plans and rolling forecasts. The Department now produces 'traffic light' early warning reports on the financial position of each operator.
4.9 Ultimately, where a train operator can no longer continue operations, the Department has a statutory duty to intervene and become 'operator of last resort' until the railway is re-franchised. Each train operator must deposit a performance bond for the benefit of the Department. Should the franchise default, the Department would recover termination costs from the performance bond.
4.10 In 2006, the Department's arrangements for dealing with a franchise in difficulties were tested when the parent company of GNER, the operator on the East Coast Main Line, was unable to support GNER during a period of financial difficulty. The Department negotiated a solution which protected taxpayer's interests (Figure 17 overleaf). The original franchise had been let by the SRA in 2005, with a net present value of £1,200 million in franchise premium, payable by GNER over the life of the franchise. In August 2007, following a new competition, the Department let the franchise to National Express for future franchise premium with a net present value of £1,300 million (in 2005 values).xiii
4.11 On the risks caused by an economic downturn, the revenue risk sharing arrangements protect train operators to some degree from economic downturns (paragraph 2.11). But significantly lower economic growth would cause commercial problems for some franchises.
4.12 To manage this risk, the Department reviews the plans put forward by each bidder to cope with, typically, a ten per cent shortfall in revenues and then calculates the amount of additional financial support that the bidder's shareholders might need to guarantee. These mitigants are designed to cope with relatively short-lived declines in revenues. For more sustained declines, the re-letting solution adopted in the case of GNER would be available. But re-letting may be more difficult in an economic downturn because franchise values would be reduced resulting in a lower premium or a higher subsidy.
17 | Showing the outcome of re-letting the Inter city East coast franchise | ||||||||||
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GNER - the re-letting experience The original franchise: A seven year franchise was let in May 2005 by the Strategic Rail Authority (SRA), renewable for a further three years if GNER met targets. GNER committed to make premium payments with revenue risk sharing from the outset. GNER had committed to investing: up to £75 million to refurbish and improve High Speed Trains; £25 million on station modernisation; at least £3 million on improving passenger security and £5 million elsewhere. Management Agreement with GNER: A year and a half into the franchise, GNER approached the Department forecasting difficulty with meeting financial obligations at a time when its Bermuda registered parent company Sea containers was facing bankruptcy. In December 2006, the Department and GNER negotiated a deal to pre-empt an event of default in making franchise premium payments during 2007. As part of a settlement, GNER's parent company agreed to pay £2.5 million to cover the Department's external costs and costs of re-letting the franchise early. Some project plans were affected by the early termination, causing some delay in benefits for customers. Incentives to protect franchise value: Instead of a management fee, GNER retained certain cost savings and above target revenue was shared equally with the Department, aiming to increase franchise value. At re-letting the Department has secured the prospect of an additional £100 million premium over a shortened franchise life. Source: National Audit Office Summary | The new inter City East Coast franchise: On 14 August 2007, the Department announced a new contract with NXEc Trains Ltd, a subsidiary of the winning bidder National Express Group plc. It runs from 9 December 2007 to 31 March 2015 with the final 17 months conditional on set performance levels being reached. Increased revenue-sharing provisions compared to GNER: In the event of excess revenue between two per cent to six per cent above target revenue, the Department will receive 50 per cent (up from 40 per cent), increasing to 80 per cent (up from 60 per cent) for revenue greater than six per cent above target revenue. The provisions for revenue support, if needed, commence after four years (improved from an immediate risk share). Passengers: Passengers will benefit from increased capacity, reduced delay minutes, a simpler website and more environmentally friendly elements to the journey. From December 2010, 25 extra train services will be run on weekdays, with up to 40 new carriages providing 14,411 extra seats, subject to Network Rail's strategy for the route. Among the extra services will be new London-Lincoln and London-York services operating at two hourly intervals as well as faster journeys to places like Leeds, York and Edinburgh. There will be a £7.4 million upgrade to stations and increased car parking. NX East coast is committed to achieving an overall reduction in delay minutes attributable to NX East coast of 29 per cent by the end of the franchise. | ||||||||||