3.19 The project will be successful if the Tunnel delivers the Department's strategic objectives while risks and costs are managed. Contractual arrangements for costs and payments (including 'pain/gain sharing' of cost variations between customers, contractors and shareholders) provide Bazalgette and its contractors with financial incentives to deliver on time and manage the risks of cost overruns.
3.20 Contractors will be rewarded financially for achieving time milestones and cost savings, where doing so achieves a cost saving for the overall project. Conversely, financial penalties will be applied for late completion or cost overruns. Although both contractors and equity investors are shielded from the full extent of any overspend or insurance claims on the project, their overall returns on the project will be higher if these do not occur. Contractors will be liable for deficiencies in their works for 12 years after completion, and the Environment Agency and Ofwat can take enforcement action against both Bazalgette and Thames Water if either company fails to meet its obligations with respect to the Tunnel.
3.21 Under Ofwat's regulatory framework, customers and companies will share in gains from lower than expected costs, and in losses if costs are higher than expected:
• Bazalgette. Customers are liable for 60% of overspends between the target price of £3.2 billion (in 2014 prices) and the £4.1 billion cost overrun threshold, subject to Ofwat agreement that overspends have been efficiently incurred. Customers will share in 70% of the benefit of any underspends against the target price. The contractors will share losses from overruns in their sections equally with Bazalgette up to a limit of 25% of the respective contract's value.
• Thames Water. Customers will absorb 50% of the impact of both over and underspends on the Tunnel-related expenditure in Thames Water's 2015-2020 business plan. Customers will also share in 100% of any gain or loss on the proceeds from sales of excess land after construction ends.
• Alliance agreement. To promote cooperation, three main works contractors together with Thames Water are collectively financially incentivised through a rewards and penalties regime to achieve cost targets and time milestones during the construction period.
3.22 The Department has a monitoring framework for project progress and risks. Governance arrangements include quarterly meetings involving key project stakeholders, and regular meetings between ministers and officials to monitor progress throughout construction. The Department has appointed a loss adjuster, Crawford & Co., to ensure any claims made under the insurance element of the GSP are fair. Independent technical assessors (Mott MacDonald) and technical advisers (OTB Engineering) will provide quarterly assessments on Bazalgette's reports on progress and project costs, with the latter reporting exclusively to the Department. These assessments fulfil a dual role, enabling Ofwat to identify and disallow expenditure which has not been agreed, and providing advance warning of a call on the GSP so the Department can make appropriate preparations.
3.23 The government can restrict Bazalgette's access to the GSP and impose financial disincentives for specified circumstances (such as Bazalgette breaching financial covenants) if the company does not correct the situation in accordance with the remediation regime. The Department has no executive role in managing cost control on the project, but where forecasts indicate a project-level overspend, the Department can require Bazalgette to produce a mitigation plan to reduce or correct the overspend.
3.24 The Tunnel is expected to start delivering benefits by 2024 and to deliver optimised performance after the testing period ends in 2027. Our assessment is that a risk remains that the UK is fined for non-compliance with the Directive prior to this period, despite construction work starting and the prospect of the UK leaving the European Union. The European Commission told us that they have not yet reached a decision on whether to seek fines. In London's case, the scale and complexity of the project and the UK government's stated intention to leave the European Union create uncertainty over this issue. In principle, the UK would be liable to pay such fines while still a European Union member. A range of matters, including any post-exit implications of any judgments of the Court of Justice of the European Union concerning the UK, will be subject to the forthcoming Article 50 negotiations with the European Union. We have not audited or considered the effects on this project of leaving the European Union.