The Office of Rail Regulation (ORR) announced on 26 April its decision to refer the leasing of rolling stock for franchised passenger services to the Competition Commission (CC). The CC will now carry out its own comprehensive investigation, to see if any features of the relevant markets prevent, restrict or distort competition and, if so, what action should be taken to remedy the adverse effects on competition. The CC has already asked for comments from interested parties by 25 May 2007 and is required to publish its final report by 25 April 2009.
The ORR’s findings
In a lengthy reasons paper, the ORR identified the key problem as the lack of liquidity and competition within the market. This is due to a number of features including:
- The different characteristics of rolling stock means that there is limited interchangeability of stock between routes
- Limited availability of surplus stock
- Restrictions in some Invitations to Tender for franchises
- Franchises are shorter than the asset life of the rolling stock and are awarded at different times
- Limited new build in the absence of Government support
- High costs of transferring stock between franchises
- Limited incentives by Train Operating Companies (TOCs) to negotiate over lease terms given the “pass-through” of their costs to Government subsidies or premiums
The ORR concluded that high profits, low switching rates of TOCs between Rolling Stock Leasing Companies (ROSCOs) and low standards of maintenance service indicated that competition was not working.
The ORR pointed out that the three incumbent ROSCOs - Angel Trains, Porterbrook Leasing and HSBC Leasing - own 96 per cent of rolling stock and this situation has persisted since privatisation. The ROSCOs state that, irrespective of their market position, they are constrained by the risk of damaging future relationships with the TOCs. The ORR considers, however, that there is no incentive on the part of TOCs to exercise this buyer power.
Suitability of a reference
In deciding whether or not to make a reference, the ORR considered it’s costs and benefits and the availability of remedies. The rail industry currently spends over £1bn per year on rolling stock. Of this, the DfT calculates that there is a ‘consumer detriment’ of between £34 million and £177 million per year - money which could be returned to taxpayers and passengers if the market worked properly.
Concerns were raised during the ORR’s market study as to whether issues linked to the DfT’s franchising processes were capable of remedy by the CC. The Department for Transport (DfT) argued that changes to its franchising policy would not be possible given that the “Government has set the framework of passenger franchising in which competition for the supply of rolling stock needs to take place and upsetting that framework in order to drive competition into a malfunctioning part of the rail sector is not an option which merits serious consideration”. The ROSCOs added that neither the ORR nor the CC have the authority to legislate or force the DfT to change its procurement practices. The ORR appears to acknowledge that certain matters, such as franchising policy, fall within the DfT’s exclusive remit. Nevertheless, it hopes that a thorough investigation by the CC will enable a developed view on available remedies to be reached and result in a more reliable market which will benefit all parties concerned.
OFT Guidance on market studies make clear that a referral to the CC (either by the OFT or a sectoral regulator, such as the ORR) will not normally be appropriate where the adverse effects derive from Government policy. In such circumstances, it is appropriate to submit a report to the Government instead. This was the approach adopted by Ofcom following its investigation into the price of making telephone calls to hospital patients in January 2006. In the case of rolling stock, the DfT encouraged the ORR to refer this matter to the CC but only to consider behavioural remedies, such as price regulation. The ORR has gone a stage further and has suggested that market remedies, including possible farreaching changes to the franchising process, should be considered. Indeed, many of the competition concerns raised by the ORR relate to the franchising process.
The scene is set, therefore, for a long and demanding contest. Not only between the CC and the ROSCOs, but also possibly between the DfT and the regulators. The CC will examine the ROSCO’s alleged high profits and poor service. But it will also consider how the dynamics of competition can be improved in the rolling stock market. In doing so, it will necessarily explore the boundaries of its jurisdiction to implement remedies which impact on Government policy and the DfT’s executive powers