2. Challenges to securing private investment in UK rail infrastructure

There are some common challenges to bringing private investment into rail, falling into four main areas which we have set out below. However, as demonstrated in the following section, these challenges are not insurmountable.

Challenge 1: Lack of clear Government policy on rail and private investment: There is currently no coherent Government policy that provides the market with the clarity and certainty it needs to attract more private sector investment in the UK rail network. Over the past five years, several reports and papers have recognised the need for progress, but there is a need to collate the insights into one coherent UK policy:

● The 2017 Hansford Review, a Network Rail commissioned independent review, examined how Network Rail can unlock third sector involvement in funding and financing rail infrastructure. 30 The review found that there is a ‘lack of routine and repeatable way that private sector companies could invest, manage risks and achieve a financial return for managing Network Rail’s infrastructure projects.’

● In 2018, the Department for Transport launched the ‘Rail market-led proposals’. 31 The objective of this was to increase overall investment in the railway while relieving the burden on taxpayers and farepayers. The Department held a call for proposals for schemes that would be financially credible without any government support, and received 30 submissions. It is unclear what progress has been made on this since then.

● The Government’s Rail Network Enhancements Pipeline (RNEP) included an ambition to ‘consider opportunities for alternative sources of private funding and private finance options at each stage of the pipeline.’ 32 The RNEP, which was supposed to be an annual publication, has not been updated since 2019.

● The UK Government Green Financing programme has been able to attract private finance, through green gilts and bonds, with infrastructure projects that have clearly defined environmental benefits, including some ‘clean transportation projects’. 33 In the financial year 2021-22, a total of £6m was allocated to expanding and maintaining the UK’s electric rail network as part of the programme. Whilst this is a welcome step, there is still untapped potential and private sector appetite to invest.

● The creation of the UK Infrastructure Bank (UK IB) was announced in 2020, as part of government plans to support private investment in infrastructure. The UK IB aims to crowd in private capital over time, and can issue guarantees for infrastructure projects backed by the Sovereign Infrastructure Guarantee. 34 There is a significant opportunity to build on this, focusing on rail projects.

Challenge 2: Complexity of contracts: Rail infrastructure projects can be complex, especially when they interface with the live rail network. Such projects can involve a range of bespoke risks, for both public and private sectors, which means that investment schemes often need to be bespoke.

● A 2019 Centrus report highlighted how private financing of rail will entail different parties having an ownership interest in assets that are part of the live rail network, which may now be owned by, for example, Network Rail. Assets on the live network include track, signalling equipment, tunnels, new junctions, stations when including track interface, depots when including connections, and electrification assets. This entails added complexity with regards to ownership, maintenance, and safety. 35 It means that getting risk allocation right and well understood is crucial.

● Global investors are comfortable dealing with proposals which have well established and understood arrangements for risk transfer. The Global Infrastructure Hub has identified key risks associated with rail transactions including land availability, access and site risk, construction risk, operating risk, and demand risk. 36

● We have heard from RIA members in the rolling stock sector how the public sector variations to contracts are changing risk allocation in tender proposals – unless carefully tested from a commercial perspective this is likely to create additional complexity and deter well established investors (potentially increasing the cost of finance over time). Deviating from these without significant justification risks driving out investors.

Challenge 3: Intelligent market engagement: Several challenges exist in the way in which the public sector engages with the private sector. There is room for improvement in key areas such as:

● Too often procurement notices are issued for schemes that are unlikely to go ahead. This adds unnecessary cost to projects through significant resources being put on bidding and scheme development. For example, the lack of follow up on the Department for Transport’s 2018 market-led proposals created costs rather than opportunities.

● The private sector’s ability to retain intellectual property is key to achieving private sector participation. When innovative ideas are suggested, too often procurement practices require the full scheme to go to market, undermining intellectual property rights. This hinders innovation: why would a company innovate if it cannot recoup the costs by being the party which delivers the solution it has developed?

Challenge 4: Balance sheet classification and cost of public borrowing: Several challenges exist with regards to public accounting rules and the differential between public and private costs of borrowing.

● When proposals are made for privately financed rail infrastructure in the UK, they are often classified as being 100% on the Government balance sheet, despite the public sector share of risk being low. This happens where, for example, the revenues generated by investments are accrued in the public sector, or if the public sector has underwritten ‘extreme event’ risks.

● Good public sector balance sheet management is essential. However, current rules and decisions are complex, opaque and result in binary on/off balance sheet decisions (i.e. 100% on or 100% off), rather than an accurate reflection of the split of private and public liabilities and assets.

● Sometimes, even schemes which have a positive financial business case and are not projected to require any Government money are rejected on balance sheet grounds. The cost is ultimately one of lost opportunity. An example is the Heathrow Southern Rail link.

● When schemes are declared ‘on balance sheet’, the full value is then added to the national debt and HM Treasury consequently rules out using private finance, because the public cost of borrowing is usually lower.

● With scarce public funds as the only remaining option, many viable investments cannot progress. For example Beam Park Station in East London was not supported by the Department for Transport on economic viability grounds, despite the fact it would be on a line supporting 20,000 new homes, clearly requiring access to public transport. 37

● This approach does not recognise wider benefits (efficiency, innovation, investment smoothing) which private finance can bring and may more than offset the cost of capital. There is rarely comparison of the whole life costs of using public and private finance. Given government budget constraints, projects then generally do not progress further, resulting in an uneven and insufficient infrastructure investment.

DEFINITION:

If a scheme is “off balance sheet”, this means that it does not affect the Government’s financial position (as measured in the national debt, reported by the Office for National Statistics) and that the assets and future expenditure are not considered as liabilities to the Government, as they are owned by an external party.

3. Meeting the challenges

As set out above, there are some common challenges to bringing private investment into rail, but they are not insurmountable. Significant value could be unlocked by considering some of the key opportunities.

First, how can we address the challenges set out above? RIA has identified four asks of the UK Government.

Ask 1: A clear Government policy on rail and private investment: There is an opportunity for the UK Government to craft a general strategy on private finance and funding for infrastructure as a means to complement public funding and to boost economic growth and productivity. The policy should provide long-term certainty of approach, to provide confidence over the life-cycle of investments. Such a policy could unlock growth in a number of industries and sectors, including rail infrastructure. While it does not have to be rail specific, the policy should be explicit about the fact that it applies to the rail industry. To ensure its correct application, this policy should be accompanied by a bespoke unit sitting within HM Treasury which can provide cross-departmental advice, support and momentum.

Ask 2: More pathfinder projects and standardised approaches: There is an opportunity to bring forward trailblazer projects, providing proof of concept using less complex schemes that could provide frameworks to replicate for future investments. The private sector is ripe with ideas and experience for how to successfully execute such schemes. This can then be built on, together with key stakeholders, as a basis for more complex schemes. As part of this there needs to be action to address the findings of the Hansford review – we need a clear and specific route-map for opportunities to invest in rail schemes (although this needs to be underpinned by the wider Government strategy). There is an opportunity for greater cross sector learning to leverage private investment, particularly from experience in the nuclear and water sectors.

When developing schemes, the public sector should take into consideration established market practices to risk allocation. Additionally, using standard form contracts, with well understood and internationally recognised approaches to risk allocation could help attract a large volume of private investment as well as reducing procurement duration and keeping down legal fees.

Ask 3: Intelligent market engagement and a targeted review of procurement practices: There is a real opportunity to harness private sector innovation, but in order to unlock this the public sector must effectively engage with the private sector. This includes taking an ‘intelligent client’ approach to procuring and considering the costs incurred by the private sector in the bidding process.

Procurement practices must also be ‘innovation friendly’ in terms of allowing the private sector to retain and build on intellectual property. Understanding and accommodating for established ways of allocating risks means that the public sector is able to engage with the market in the most cost efficient way. Projects in other sectors have overcome these challenges, such as the Thames Tideway Tunnel.

Ask 4: Fair comparison of the costs and benefits of private finance with public borrowing: Government appraisal methodologies need to explicitly assess the potential benefits of using private finance: transferring risks of cost escalation supported by stronger financial incentives (private finance creates ‘skin in the game’ and will typically be accompanied by both debt and equity finance). These can help reduce the chances of over-spend, scope creep, and programme delay, and support innovation (provided that contracts are focused on achieving results, and not providing tightly specified inputs).

A 2019 National Infrastructure Commission report identified that a fair comparison of private and public finance requires decision makers to look at costs and benefits:

● Over the whole life of the project, from development to decommissioning;

● In the context of the economic environment and the industry – noting that a sustainable industry will lead to long term value for money;

● Beyond the focus on financial measures, taking into account wider outputs and outcomes the project is delivering – including quality of services, asset quality and condition and the enabling of innovation. 38

The outcome from a 2020 Government consultation on infrastructure finance noted that new off-balance sheet private finance models would be needed to ‘fill the gap’ created by the 2018 retirement of the government policy on public-private partnerships and given wider fiscal constraints on the level of government spending. 39 The Government needs to act on this finding, and should review the approach to balance sheet classification with the objective of fairly reflecting the share of public sector risk in each project.