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The Strategic Rail Authority successfully managed the termination of Connex South Eastern’s franchise after the SRA lost confidence in the company’s financial management, according to the National Audit Office. Taxpayers’ interests were largely protected and passenger services maintained. But this case did highlight lessons for the awarding and managing of franchises.

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In June 2003, the Strategic Rail Authority, which awarded and monitored rail franchises run by Train Operating Companies (TOCs), decided to terminate early Connex South Eastern’s (CSE’s) franchise for providing passenger rail services in Kent, parts of East Sussex and South East London. This is the only occasion to date that a franchise has been terminated early. According to today’s report to Parliament by head of the NAO Sir John Bourn, taxpayers’ interests have, on the whole, been protected and South Eastern Trains (SET), a subsidiary of the SRA, has improved services and increased passenger satisfaction since taking over the franchise in November 2003.

Connex ran into financial difficulties early in the life of its franchise, which it had won with an ambitious bid in 1996 when the government was typically awarding franchises to bidders requiring the lowest subsidies. CSE failed to achieve expected reductions in operating costs because, in common with other TOCs, its wage and driver costs were much higher than anticipated. The SRA’s attention was focused on the short-term solvency of TOCs and it remained unaware of CSE’s financial difficulties until CSE requested a two-year extension to its 15 year franchise and additional subsidies to fund capacity and service improvements. The SRA subsequently identified a funding gap that would require additional subsidies of between £384 million and £820 million through to 2011, the scheduled end date of the franchise. But there was uncertainty about how much more subsidy CSE really needed. The SRA also had concerns about weaknesses in CSE’s financial management, including the transparency of its reporting of transactions with sister companies.

In December 2002, the SRA agreed to provide CSE with additional funding of £59 million during 2003 to stabilise its finances. CSE was given a deadline of 31 March 2003 to improve its financial management, control and reporting. CSE’s franchise term was also reduced by 5 years, to December 2006. The SRA also agreed to enter into negotiations for further additional subsidies for 2004 to 2006. However, while CSE’s financial management and reporting did improve from January 2003, reviews by consultants engaged by the SRA found that CSE’s progress was slow and fell short of full compliance with what the SRA required, although the extent and nature of the engagement between the SRA and CSE at this time was unclear from the documentation we have seen. The SRA concluded that the TOC would not be able to satisfy it within a reasonably short timescale that the additional subsidy sought for 2004 to 2006 would be applied efficiently and economically. This led to the SRA’s decision to terminate the franchise.

After announcing the termination of CSE’s franchise, the SRA managed the risks well, in co-operation with CSE, and secured the smooth transfer of operations to SET within five months and without disruption or any significant deterioration in passenger services. The SRA secured a reasonable financial settlement upon CSE’s exit from the franchise in November 2003 and recovered £2.8 million of its own costs from CSE. The SRA decided not to exercise its contractual right to recover further costs totalling £1.8 million, as it was concerned about the significant financial and operational risk of Connex becoming insolvent in the face of such claims. Nor did it seek to recover other costs of £2 million that it spent on several reviews of CSE’s financial difficulties and financial management leading up to the termination decision. The SRA believed that no useful purpose would be served in seeking to recover costs that it had no contractual right to recover, and that doing so would have undermined already difficult exit negotiations and increased the risk of Connex insolvency.

The SRA equipped SET to manage the franchise effectively from the outset and SET has controlled its costs well. As the franchise is now in the hands of a public body and the risk of fare evasion rests with the taxpayer, action has been taken to strengthen revenue protection measures. SET is on course to cost the taxpayer £6 million (2 per cent) less than originally expected. Although SET’s costs are likely to be £22 million (8 per cent) higher than the amount of subsidy that CSE was prepared to accept to continue to run the franchise, the SRA had little confidence that CSE would have kept within this amount.

SET has improved its operational performance in line with similar London commuter TOCs, although better Network Rail performance has been the single biggest factor in this. Passenger satisfaction is now at its highest level for the franchise since the National Passenger Survey started in 1999, but, like CSE before it, SET still has one of the lowest passenger satisfaction ratings of all TOCs.

“The seeds of Connex South Eastern’s difficulties were sown when the train operating company won its franchise with an over-ambitious bid. It indeed subsequently proved to be undeliverable. The Strategic Rail Authority lost confidence in CSE and took the difficult and finely balanced decision to terminate the franchise. The SRA went on to demonstrate that the successful termination of a train operating company’s franchise is feasible, and that taxpayers’ and passengers’ interests can be protected, through careful management of the attendant risks.

“This case highlights lessons to be learned, however, in how franchises are awarded and managed, which the Department for Transport must keep in view as it takes forward the responsibilities it has recently inherited from the Strategic Rail Authority.”

Sir John Bourn


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