New Train Set

The Hansford Review sought to put ‘contestability’ at the heart of Network Rail’s future. Paul Jarvis finds out what that means for private finance opportunities

Rail depots may not be something that get people immediately excited, but they could yet provide the new frontier for investors in the UK infrastructure market.

At the end of July, Professor Peter Hansford of University College London published his report into ‘contestability’ in the UK rail market. It was clear in its findings: “In summary, there appears to be a lack of considered choices being made between different contracting options in the current arrangements,” it said. “For certain projects the private sector could deliver at lower cost if a different contracting model and risk apportionment were used.”

Among its recommendations were a number of suggestions that should pique the interest of the PPP market, which already has a long association with the sector – generally through rolling stock procurements.

What the Hansford Review is proposing is far more wide-ranging. In particular, it recommends Network Rail work with government “to identify a range of pathfinder projects to demonstrate the removal of barriers and the benefits from alternative funding and delivery models”.

Network Rail has been highly receptive to the plans, with chief executive Mark Carne suggesting that the first schemes could be launched before the end of the year, as the organisation looks to transform its approach to the procurement of infrastructure.

In September, a prior information notice (PIN) was issued for what may be the first of these new schemes, with Network Rail Infrastructure seeking interest in the development of the Deansgate Station in central Manchester.

“The Deansgate PIN is a good place to start,” suggests Andrew Herring, partner at law firm Squire Patton Boggs. “It means the market is going to be thinking about what the issues are and generally getting ‘match-fit’ for when more projects come along.”

“Initial projects are going to be pretty small: stations, car parks and depots,” says Tammy Samuel, partner at law firm Stephenson Harwood. “Small to start might be a good thing, to test the market and get a structure together that works in a rail context.”

Most agree that while there may be a number of early projects to whet the industry’s appetite, establishing a longer pipeline may take some time, as a major shift in thinking and culture within Network Rail will be needed.

“The review identifies the need for Network Rail to re-educate itself,” continues Herring. “In its defence, it is a sector where it is in all our interests for it to follow rigid norms in many areas because that is safety critical.”

So why did Network Rail choose to commission Professor Hansford to undertake its review in the first place? The catalyst was the revision of Network Rail as an on-balance sheet organisation, with it officially becoming a public body in 2014. With all those liabilities now on the government’s books, finding ways to provide the required investment without adding to that debt became an important priority for the organisation.

As one adviser puts it, private finance should always be seen as what can be done to deliver infrastructure that is over and above what can be done with money from the exchequer. And that is exactly the kind of intervention Hansford is supporting.

“The government wants to see Network Rail be a public organisation that behaves like a private organisation,” says Herring.

“Rail looks like the great hope in terms of the introduction of private capital,” adds Darryl Murphy, head of infrastructure debt at Aviva Investors. “If it has a PPP-type structure adapted for rail then it will be a good opportunity.”

The question now, however, is what can be financed?

Project chasing

As the first project of its kind since the Hansford Review was published, the Deansgate project is probably the best example of what Network Rail expects schemes to look like. Under the plans, a development partner will design and develop the station, with Network Rail seeking to balance improvements for rail customers with extracting greater commercial value from the site.

“The further away from the rail itself, the easier it becomes,” says Samuel. She points to work on depots, which can be seen as separate entities to the rail line itself, and so have relatively little impact on the operation of the rail network.

“However, the commitment to pay is probably only for the length of the franchise and therefore financiers need to be able to take a railway view (ie that the railway needs the asset on an ongoing basis),” she adds.

“Depots are the lower hanging fruit,” agrees Stephen Williams, a director in MUFG’s infrastructure team.

So far, so ordinary. There are plenty of projects that have been undertaken across the country over recent years to build new depots, or to commercialise stations in major cities and at important terminals, by creating retail space that can capitalise on the throughput of commuters and holidaymakers.

However, the Hansford Review hints that much more can be done in the long-term, and there are plenty in the industry who agree.

“The real opportunities are around digital railways: signalling and communications,” suggests Williams. “These allow for trains to be closer together and therefore they can be used more efficiently.”

Murphy and others agree that this is an area ripe for private innovation, where investors could bring added value to the existing rail line.

However, not everyone agrees that digital infrastructure is an area that the private sector should be getting involved in. “I don’t think PPP works well for something that is high technology like digital signalling, because change in the system is too likely,” says Jonathan Turton, director at consultancy KPMG. “You don’t want to be financing it over 25 years because of the technology challenge and the pace of change.”

Given some of the thoughts around what might happen on the roads over the coming decades – such as driverless cars and so-called lorry platooning – possibilities such as driverless trains must be an important consideration that could yet revolutionise the way trains operate, leaving the technology of today potentially outmoded within the next 20 years.

“The issue is seeing private finance as a panacea for digital installation and other technology driven change,” Turton continues. “It is really hard to transfer risk properly in that situation because too much is unknown.”

Instead, Turton argues the real opportunities can be found in the hard infrastructure, such as the track itself – which is unlikely to become obsolete in the next 20 years. Critical to all this, however, will be the scale of the opportunity on offer. If Network Rail simply throws out a few station upgrades and depot projects without offering anything that indicates a true pipeline, it will struggle to grab the attention of investors.

“The question is should we be wasting our time and all that energy on a few contracts in the UK?” asks one technical adviser. “To really push into the area, knowing we are against five other technical advisers, for a small pipeline of projects, is that worth our while? There is a lot of pricing pressure on technical advisers in the UK.”

The key thing here will be establishing a pipeline that the industry sees as exciting. Samuel believes this will emerge, but suggests it is unlikely to happen at scale until after 2019, when Network Rail is into its next control period and has visibility on its own spending capability for five years.

“There needs to be identification of potential projects; suitable risk allocation; and a long pipeline whereby teams will invest in bidding for these projects,” adds Williams. “Doing all that will create a competitive universe. To get to that point needs a significant shift from where we are now.”

And doing things differently doesn’t always come naturally to the rail sector. One adviser points to the situation in rail franchising, where the public sector has often given the impression that it wants more innovative arrangements to be brought into that market.

However, when it comes down to the final bids, most train operating companies find things such as adding an infrastructure element that is not required as part of a bid “gets put into the too difficult box”, as the technical adviser puts it.

“Rail is well covered from an engineering point of view, but not from the ‘thinking outside the box’ point of view,” he adds, suggesting that this is where the PPP industry needs to be stepping in to provide some fresh input.

A new frontier

The first sight of some fresh thinking could come from the East West Rail project. In December last year, Transport Secretary Chris Grayling intimated that private finance could form part of the funding mix for the scheme to develop the rail line along the Oxford to Cambridge corridor.

Since then, East West Railway chair, Rob Brighouse, has elaborated on some of the thinking behind the potential for investment.

In a speech to guests at an event hosted by Stephenson Harwood and Atkins, Brighouse laid down some key points, including that the company is not looking to come up with a completely new structure.

Rather, his team believes there are tried and tested regimes in the infrastructure and rail industries that should be reviewed and adapted for this scheme. He suggested that this will make it easier to get off the ground and finance.

One view expressed during that discussion was the potential for the government to build the railway first, then use private finance later, effectively replicating models such as that used on HS1.

However, it is understood that the government and Network Rail are looking to be more ambitious. As Brighouse explained, the ability to realise value that is generated by the railway is vital to its success.

As a result, there is a growing clamour to use some form of value capture approach. “Value capture is increasingly important,” says Herring. “The arrangements around Crossrail were deemed a success.”

How the concept might work in practice, though, is currently a moot point. “Where is the state/private divide on value capture?” Herring continues. “It is an emerging debate.”

The public sector is understood to be keen to get the private sector to both finance the rail line and take the risk on capturing value from the route. “There could be interest from a land developer within a consortium to do this,” says Samuel.

Not everyone is convinced. “A DBFM availability-based model brings a more predictable revenue stream. In parallel, value capture schemes can be pursued that can reduce the net contribution required from government,” says Williams. “To combine them and put the real estate risk on the same contractors and investors is unlikely to get the best value for money.”

“You could get people to take the risk on value capture, but I don’t think the return they would want would provide value for money for the public sector,” suggests Turton. “You would have to underwrite the risk to some degree if you wanted to use it to finance elements of large projects in a value for money way.”

Samuel argues against this, saying that there is a strong drive from the public sector to push out these types of risk to the private sector.

“Land value capture is flavour of the month at the moment,” she says. “I don’t think it will work just to say the government is best-placed to do all that and financiers will need to consider if and how they can build this into their structures.”

Murphy, though, believes there is a realism within the public sector that recognises it will be hard to tie the value capture elements to infrastructure financing. Turton has another objection to the value capture concept, too. “Where does the ‘value’ occur? If you look at a track, the value tends to be at and around the main stations. In each case, the city where it ends up sees that value as their own added value, not that of the line.”

Even on a project like Crossrail 2 – which offers far greater opportunity for value capture because it will connect many urban areas of London – there are doubts that Transport for London will be able to claw back even a third of the overall cost through value capture techniques. When the model is used on a line that runs through a series of fields for several miles without stopping, the prospect of any significant value uplift becomes even more remote.

Network Rail might be willing, and investors might have the appetite. But there is clearly still plenty of work to be done to hammer an acceptable private finance pipeline into shape in the rail sector.