Public expenditure impacts
10 In restructuring the deal, the Department avoided any material increase in the net amount of direct grant payable to the project. Nevertheless, the restructured deal now depends on the Government having issued various guarantees and undertakings to lend money directly to LCR. This means that the taxpayer is exposed to considerable financial risk if Eurostar UK does not perform as well as expected against revised forecasts. Set against that risk, the Department will share in any long-term profits if the business is successful.
11 The Link will be financed from a complex mixture of public and private finance and guarantees:
a) In the short term, and beginning during the re-negotiations, LCR conducted a sale-and-leaseback of eleven of its Eurostar train sets, with the Government guaranteeing LCR's obligations amounting to £230 million, pending the arrangement of long-term finance (paragraph 2.2);
b) LCR has raised long-term finance of £2,650 million and expects to raise a further £1,100 million through the issue of Government-guaranteed bonds. LCR took the view that an issue of equity would not succeed, and that it would not be practicable to borrow such a large sum from banks. Our advisers, RBC Dominion Securities agree that the bonds represented good value in terms of the rates of interest payable, compared with what was available in the loan markets at the time (paragraphs 2.4 to 2.6).
c) Railtrack is obliged to buy Section 1 from LCR, and has guaranteed part of LCR's borrowing. Railtrack will pay the actual cost of construction, including an allowance for the interest costs incurred by LCR, less the direct grants to be paid by the Department to LCR. Railtrack has also guaranteed up to £700 million of commercial bank borrowing by LCR for the specific purpose of financing the construction of Section 1 (paragraphs 2.7 and 2.8).
d) In addition to direct grants, the Department has guaranteed payments from Eurostar UK to Railtrack and has provided a capped loan facility for LCR to draw on, depending on how Eurostar UK performs in the future. Direct grants under the restructured deal of £2,010 million3 will be paid towards the construction and operating costs of the Link. In addition, the Department has guaranteed the payments Eurostar UK will be due to pay Railtrack as owner of Section 1. These "track access charges" are based on the same principles as those applying to the payments by other train operating companies for the use of Railtrack's infrastructure elsewhere on the railway system. In this deal, however, they are also the mechanism by which Railtrack will make a commercial return on its investment in Section 1 (paragraphs 2.9 to 2.12).
e) The original shareholders with a continued interest in LCR have converted most of their equity stake into preference shares carrying a fixed rate of interest. One half of these preference shares will be repaid with accrued interest on completion of Section 1 and the other half on completion of the entire Link. LCR's original shareholders did not therefore lose their original investment and did not contribute any further equity to the project (paragraphs 2.13 to 2.15).
12 The decision to use Government-guaranteed bonds was finely balanced. The Department considered that their use had advantages over the alternative of making voted loans to LCR, financed through the issue of conventional Government bonds (Gilts): a) the concept of the Link as a flagship Public Private Partnership would be maintained; b) it would avoid signalling to other potential PPP developers that the Government would be willing to take on financing risk; and c) it would keep the project off the public sector balance sheet. This last point depended on the guaranteed bonds not being classified as public sector borrowing, which followed from the Office for National Statistics being satisfied that there was a very low likelihood of the guarantee ever being called (paragraphs 2.16 to 2.18). 13 The use of Government-guaranteed bonds will, however, lead to extra funding costs by comparison with Gilts because the interest rates at which they were issued were higher than those of directly comparable Gilts. Our advisers consider that the marketing of the bonds appears to have been handled most carefully and attribute this extra cost to technical factors affecting demand from investors for the bonds. Nevertheless, the advantages over Gilts that the Department saw in using Government-guaranteed bonds were secured at a cost of some £80 million4 (paragraphs 2.19 to 2.24). |
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14 As a result of the financing structure now put in place for the Link, the taxpayer remains exposed to the financial risks of LCR's business. If Eurostar UK continues to under-perform, the arrangements made for the Government to lend LCR the money to pay Railtrack's access charges would be triggered when LCR's other cash resources, including the money raised from the Government -guaranteed bonds, are exhausted. Scenarios considered by the Department at the time of the restructuring show that between 2010 and 2021 a shortfall ranging from nil to £360 million might arise. A more recent forecast of Eurostar UK performance suggested a range of £360 million to as much as £1,200 million under extreme circumstances. Further, but much smaller, financial exposure will arise from any future Government guarantees of LCR's potential liabilities through a highly complex series of swap transactions, which were used to hedge LCR's risks from changes in interest rates (paragraphs 2.25 to 2.32).
15 In restructuring the deal, however, the Department ensured that the taxpayer stood to benefit in the event of Eurostar UK being successful in attracting increased patronage. LCR is not permitted to pay dividends to its shareholders until 2021, but if Eurostar UK does well that restriction could be relaxed before then, provided all accumulated borrowing has been repaid. After 2021, the Government will be entitled to 35 per cent of LCR's pre-tax cashflow and, if LCR is sold or floated, the Government would receive 90 per cent of the proceeds (paragraphs 2.33 and 2.34).
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3 Future cashflows in the restructured deal were evaluated at 1997 prices, discounted at 6 per cent real to 1997. Direct grants (£1,730 million) agreed under the original deal increase to £2,014 million when expressed in 1997 prices, discounted at 6 per cent real to 1997. In the rest of this report, future cashflows are quoted at 1997 prices, discounted at 6 per cent real to 1997, unless indicated otherwise.
4 As at February 1999, the date the Government-guaranteed bonds were issued.