Privately financing rail enhancements: Government’s latest push

Following its reclassification to the Government Balance Sheet, the days of Network Rail delivering billions of pounds worth of investment each year, financed by borrowing against its regulatory asset base are gone. Indeed, whilst DfT has allocated £10bn of funds for enhancements in Control Period 6 (CP6), these are predominantly for projects carried forward from CP5.

With the Shaw and Hansford Reviews, Government made clear its intent to find new ways of delivering enhancements that bring in private sector funding, financing, expertise and innovation. Building on this, the Secretary of State has now launched two papers: the long anticipated guidance on Market Led Proposals (MLPs) and a document entitled "A New Approach for Rail Enhancements".

Looking at the new papers, there are three core issues at stake:

  • The planning, prioritisation and sponsorship of investments
  • Supporting private financing and funding
  • Attracting private sector innovation and expertise

Robust planning and prioritisation of rail investments schemes has arguably been patchy in the past. Projects were not always filtered on a systematic basis with schemes that enjoyed political support or strong sponsorship sometimes trumping those with the best business cases. DfT's new guidance addresses this head on by setting out a detailed process for appraisal of projects to make it on to a centralised Rail Network Enhancements Pipeline (RNEP).

The guidance sets out Government's priorities for enhancements and a new process focused on creating robust business cases. Whilst this added clarity of approach has the potential to be transformative, it is notable that in the new world projects will be promoted by a wide range of different parties such as local transport agencies, LEPs or the private sector. This leaves the risk that the strongest advocates, and not the best projects, could prevail. DfT will therefore need to play a vigilant coordinating role to ensure that public sector support is channelled to where it will deliver the greatest benefits.

Funding and financing are critical issues given Government's fiscal constraints. My KPMG colleagues have written in this blog in the last few months about the potential to fund projects with wider development potential through land value capture. Another approach is to use private finance – essentially spreading the cost of a scheme to the public sector over time. This only generally works for the public sector if the investment can be classified as off-balance sheet under government accounting rules which can only be done when certain risks are clearly transferred to the private sector. TfL is currently using this approach for its Silvertown Tunnel DBFM procurement – a project that it is unlikely to have proceeded in the foreseeable future were it required to be publicly funded up-front. Private finance can similarly be used to deliver rail enhancements and this approach is under active consideration to deliver the Central Section of East West Rail.

Private finance is certainly not right for all enhancements, indeed, it is much more suitable to schemes that are greenfield or have at least a degree of separation from the operational railway. However, in today's fiscally constrained landscape, private finance may be the only practical way that some urgent enhancements currently not in CP6 can be afforded. DfT's papers recognise this, openly indicating for the first time a clear preference for schemes to be privately financed, off-balance sheet, subject to value for money being demonstrated. HS2 Ltd is also exploring how parts of its programmes could be privately financed and brought to market so watch this space.

The final issue is involving the private sector in the origination of schemes. The Government's new MLP guidance distinguishes between projects which do not require any Government funding or support (Category 1 projects) and those that do (Category 2). Promoters are free to develop Category 1 projects subject to meeting regulatory and other legal requirements but in reality, the economics of the railway mean that these opportunities are vanishingly rare. For Category 2 schemes, the guidance sets out a detailed multi-step process of engagement with Government. The most critical part of this is two stages of public competition, firstly in the selection of the scheme itself, and secondly in selecting a partner for its delivery. DfT acknowledges the need to protect the intellectual property (IP) of scheme proponents to the greatest extent possible. However, it is resolute that competition will necessitate at least some sharing of IP.

Clarity on DfT's process for engaging on MLPs is welcome and it is apparent that the Secretary of State is seeking to encourage ideas and investment from the market. However, there is a real risk that the process described – particularly the threat of two stages of competition – could put off all but a handful of potential investors from putting serious capital on the line to develop new ideas.

DfT's approach to MLPs has been heavily constrained by procurement and state aid rules; however, DfT has stated that it remains open to adapting the approach and expects to see it evolve over time. Finding creative new ways to facilitate private investment that are still within procurement and state aid rules will be key. The proposed privately promoted Heathrow Southern Railway scheme, the most advanced MLP in contention which was singled out by the Secretary of State will be an important test case for the new approach as it evolves.

Whilst private sector investment may well have a part to play in delivering future rail enhancements, ultimately, regardless of who comes up with the ideas, most rail schemes, even if privately financed, will be funded in the long run by rail users or taxpayers. Whether it is through DfT, Network Rail or other agencies, the public sector therefore needs to play a strong, central sponsorship role both to prioritise and drive projects forward, and to ensure that value for money is delivered.