Read the peer reviews for this article
Why is the rail industry regulated? Why are some parts of the industry regulated and other parts not? Why is the Office of Rail and Road’s railway role different from its role with highways? What will the future of regulation look like? And indeed, why does rail need a regulator at all?
Not all industries have regulators. And where regulators do exist, their powers, scope and function are variable. Prior to privatisation the UK rail industry did not have a regulator, so could we do without one today? That may depend upon what a regulator is for.
Advanced democratic countries worldwide appoint regulators to intervene in certain industries and markets. The Organisation for Economic Co-operation and Development’s Recommendation on Regulatory Policy and Governance goes some way to explaining why:
“Creating a regulatory agency independent from the government and from those it regulates can provide greater confidence that decisions are fair and impartial. This may be warranted when the decisions of the regulatory agency have significant financial and market consequences and are required to be arm’s length from the political process to reduce the regulatory risk of investments.”
The Principles for Economic Regulation published by the Department for Business, Innovation and Skills (BIS) in 2011 make a similar point about the potential for unregulated government policy to be inconsistent with the timescales of investment:
“…investors will price any risk of political intervention and demand higher returns for their investment or, in the most extreme cases, might even decline to invest. This is likely to be detrimental to consumers and to the economy in the long term…
“A solution to this time inconsistency is to design regulatory frameworks that prevent unexpected change to the rules of the game, thus offering a credible commitment to investors. In the UK the statutory framework of independent economic regulation encapsulates a commitment by the UK Government not to intervene other than in clearly specified ways.”
This approach justifies an economic regulator so private sector investors can be confident that governments will not ‘change the rules’ on their investment after they have made it. It is relevant where there is a mix between government and private involvement and investment in a political or public service. This is a matter perhaps illustrated by recent debate about open access on the East Coast Main Line, and the interaction between the roles of government and ORR in deciding on the grant of such access.
Other justifications for an economic regulator tend to focus on the benefits of competition in an otherwise non-competitive market. In 1992, ahead of privatisation, the Government’s New Opportunities for the Railways noted: “The Regulator will have a central role in establishing, encouraging and maintaining a competitive railway in which the interests of passengers and freight customers, as well as those of operators, existing and new, are protected.”
The BIS view on the importance of economic regulation by bodies such as ORR also extends expressly to the benefit of regulation for competition, and thereby for consumers: “In certain sectors network effects and/or economies of scale create circumstances, such as natural monopolies, which, under current technological patterns, limit the prospects for effective competition. In these areas, independent economic regulation will be needed over the long term to continue to provide vital consumer protections and ensure consumers’ interests are promoted through efficient provision of good quality, reliable and sustainable services.”
BIS also states: “The aim of economic regulation is to create a system of incentives and penalties that aim to replicate the outcomes of competition in terms of consumer prices, quality and investment and puts the protection of consumers’ interests at its heart.”
The European Commission (DG Move) states: “The main task of the Regulatory Body is to ensure a fair and non-discriminatory access to the rail network and services.”
Overall, therefore, the reason the rail industry has an economic regulator probably has a number of strands, including:
- To provide confidence in a consistent approach for investment.
- To promote or police behaviours that would be expected in a competitive market in an industry structure which otherwise would not behave in that way.
- To produce outcomes with the consumers’ interests at heart.
We have such independent regulation because of the balance in the rail industry between public sector involvement and private sector involvement, and because parts of the market are natural monopolies which might not otherwise function efficiently.
It is this characteristic of the railways that perhaps explains the difference between ORR’s railways role and its highways role. Essentially, the assets of Highways England remain exclusively in the public sector and are (largely) provided for the public good (and, in economics terms, as a public good), so there is little balance between public and private investment for which a strong independent regulator is required.
From the point of view of economic regulation, these underlying purposes will necessarily be part of the justification for the future of rail regulation.
WHAT SHOULD REGULATORS DO?
Assuming that the industry benefits from a regulator, what should the future scope of that regulator’s obligations be?
The Government’s principles for economic regulation include accountability, focus, predictability, coherence, adaptability and efficiency. At the next level down, the Regulator’s code describes the behaviours that regulators should exhibit, and the Regulatory Enforcement and Sanctions Act requires regulators to exercise their functions without imposing or maintaining unnecessary burdens. ORR has a role to enforce safety legislation and consumer legislation (and some competition issues) on the railways.
These principles and obligations will have an impact on the future structure of regulation, by influencing what the industry needs the regulator to do and the competence and powers it will need to fulfil those requirements. They note (among other things) that “economic regulators should have clearly defined, articulated and prioritised statutory responsibilities focused on outcomes rather than specified inputs or tools”, and that regulatory frameworks should:
- “Provide a stable and objective environment enabling all those affected to anticipate the context for future decisions and to make long-term investment decisions with confidence” and:
- “Form a logical part of the Government’s broader policy context, consistent with established priorities.”
So regulators should be given clear and focused output goals derived from government policy, and have the independence to decide how to achieve those goals over an extended period to provide certainty.
CURRENT AND FUTURE DEVELOPMENTS
These principles underlying the structure of the regulator clearly involve a scope fitting with longer-term government policy. That in turn must reflect the current and developing rail industry structure. While ORR’s duties (in Section 4 of the Railways Act 1993) have developed over time with the industry, the current debates around industry structure merit a review of how the regulator will fit into any future structures.
In part, this must reflect questions raised about ORR’s recent exercise of its functions. For example, the Bowe Report called for a review of ORR’s role and responsibilities in respect of enhancements.
However, at a structural level the consideration may be most affected by the reclassification of Network Rail, potential options proposed by the Competition and Markets Authority for on-track competition (March 8 2016), and the proposals in the Shaw Report (March 16 2016), which could ultimately lead to a different delivery structure for Network Rail and perhaps licensing of concessions.
In addition, the European Union is tightening the rules for independence between parties in the Fourth Railway Package, and the ORR is taking over regulation for the whole of the UK - including in Northern Ireland and more directly with ARAF (the French Regulator) in the Channel Tunnel.
At the same time, the duties in the Railways Act (which ORR now synopsises in 22 bullet points), Crossrail Act, Channel Tunnel Rail Link Act and the Regulatory Enforcement and Sanctions Act may be due for review and consolidation, to give a tighter ORR remit.
As the Government’s principles for regulation notes in respect of ‘focus’: “It is therefore essential that the regulator’s priorities are clear. To provide clarity of objectives for the regulator and to help monitor the regulator’s performance, regulators in many sectors have been given a single overarching primary duty, typically to promote the interests of consumers.
“In a complex sector with varying objectives that can conflict, it is important that the regulator’s duties strike the right balance between setting out all relevant issues and considerations, and imposing statutory responsibilities of excessive complexity and scope.”
The Department for Transport began the process of reconsidering the needs of regulation through the launch of its Call for Evidence on Rail Regulation, issued in December 2015. At the time (pre-CMA and Shaw reports), the principal structural focus for review was the reclassification of Network Rail (and the questions in the Call for Evidence strongly focus on this change to NR).
In light of the above purposes for an economic regulator, a strong independent regulator was obviously key when government funding to a semi-private infrastructure manager (Railtrack or early Network Rail) had to be balanced with investment (output) certainty for that company and ultimately the private sector demands of franchised train operators (among others).
However, Network Rail’s reclassification arguably leads to different analyses. NR is now subject to public accounting. It is funded by government debt, not borrowing on the Regulatory Asset Base ‘credit card’. And it operates according to a Memorandum of Understanding with DfT.
Is it therefore now more like Highways England, where the proper level of regulatory involvement is limited to monitoring, advice and review? If so, is ORR’s current core role of ‘holding Network Rail to account’ (which it largely does through the Network Licence) still appropriate?
Clearly Network Rail is only part of the industry, and it is still more independent of government than Highways England. It is also subject to European law, which requires an independent regulator to control appeals from access, manage charging, allocation and competition issues.
The ‘minimum’ role of a rail regulator (within the European framework) is consequently more than ORR’s highways role, but less than its current UK Railways Act activities. Is it right to confine the regulator to that minimum role? And if not, which additional activities is it right for ORR to discharge?
The scope and powers of regulators across Europe (and elsewhere) already varies quite significantly. In France and Germany (and most of Eastern Europe), where the majority of services are not franchised to the private sector, the regulator does little more than the minimum European law requirements - potentially collecting data and advising government.
In Italy, the regulator exercises powers across different transport modes, but does not have (for example) the investment approval powers of ORR. In Sweden, the transport regulator oversees safety, licensing, approvals and the allocation and charging role. Further afield, in Japan (a vertically integrated structure), the regulator manages competition between different operators on performance.
Essentially, there is no one model for rail regulation, although ORR currently has perhaps one of the widest roles. That might be said to be a reflection of the fact that the UK’s market is one of the most liberal and its train operations almost entirely privately run.
Does that mean there is scope for reducing ORR’s role and powers, and perhaps - at least in respect of Network Rail - taking more of the economic role back into government? This may depend upon the future direction of industry development.
Nicola Shaw’s recommendations would mean a more regionalised Network Rail, with development work being proposed and approved in combination with local bodies and subject to Route-based regulatory settlements. While Shaw noted a public sense that the regulator was not sufficiently accountable, her recommendations appear to be based on (if anything) a more intensive economic role for the regulator, including close involvement in ensuring consistency within Network Rail’s projects.
At the same time, the CMA proposals for greater open access and overlapping franchises strongly suggests an ever greater need for economic regulation, and a credible body able to take and impose independent decisions on the ‘right’ option at the interface between operators.
Neither of these proposals would suggest ORR undertaking a lesser role in future. Furthermore, add the need for charging and allocation review in the Channel Tunnel, and future economic oversight of High Speed Rail (including the integration of operations with the classic network).
OTHER REGULATORY ROLES
The above analysis is principally focused on the role of an economic regulator. In the UK (and elsewhere - such as in Sweden), the regulator does not only undertake an economic role. Since April 2006 (when Her Majesty’s Railway Inspectorate (HMRI) was transferred from the Health and Safety Executive), ORR has also been the safety regulator for the railways. In that capacity it investigates safety incidents and issues guidance about the safety standards to be expected.
The alignment of the economic regulator and safety regulator in this way is widely seen as having been successful. The UK has one of the safest railways in Europe - both statistically and operationally - and its safety enforcement is seen to be conducted by specialists in the industry.
Cullen himself stopped short of recommending the transfer of safety into ORR. But the benefits identified in his Public Inquiry into Ladbroke Grove, and the resulting debate, informed the later decision by government to transfer the safety role from HSE to ORR in 2005.
The benefits identified included a joint regulator being able to more accurately assess where the costs and benefits of safety steps might lie, as well as having the overall clout to ensure that safety expenditure was properly budgeted and factored in. ERTMS, for example, is a multi billion-pound investment into capacity, efficient operation and safety. The elements are meshed, and the regulatory system approving it logically needs to reflect that.
There are currently no loud calls for safety regulation to be realigned elsewhere in the industry. However, there may be an argument that a substantial change to the nature of ORR’s economic functions or powers would in part dilute the perceived advantages of integrating safety and economic regulation. If it were determined that future regulation would be better achieved by a more limited role for the economic regulator, it might also be appropriate to consider the delivery of safety regulation at the same time.
CONCLUSION
It is likely for both commercial and European legal reasons that a privatised rail industry will require an expert independent regulator. In line with best practice, that regulator’s scope and duties should properly be clear, focused and in line with long-term government policy. However, the precise nature and width of the regulator’s role is a subject for debate, and has been implemented in different countries in substantially different ways.
Ultimately, the regulator needs to be resourced and structured to deliver the right role for the structure of the industry that is introduced. As industry structures are proposed and revisited (following reviews by the likes of Bowe, Shaw, Brown and the CMA), and where the regulator’s duties have been organically developed over 20 years of privatisation, there is good reason to reassess whether the current regulatory constitution is optimised for the future.
Where future changes to the industry are introduced (or have been - in the case of the reclassification of Network Rail), appropriate changes to the regulator should be made. However, underlying any regulator’s remit and credibility must be an understanding that investment and stability require long-term clarity about the regulator as much as the laws that bind it.
As the Government’s principles on economic regulation confirm: “In order to maximise the benefits from a stable regulatory system, Government should offer a credible commitment to restrain itself, as strategic visions should not be changed too frequently.”
Ian provides a useful summary of where we have reached in rail regulation - from a single person-led economic regulator primarily controlling access to the rail network to the more complex entity that we now have in the Office of Rail and Road.
With the continued growth of the ORR - from a small economic regulator to a behemoth with responsibility for safety regulation and the strategic highway, as well as economic regulation - for some people it has grown too big. This is even before the additional responsibilities being laid upon it following the Fourth Railway Package and the CMA proposals on overlapping franchises.
While the recent reports from both Bowe and Shaw, as well as the CMA proposals, seem to indicate a need for additional economic regulation, it is not clear exactly in what direction this growth needs to be aimed. Clear guidance from government is now required.
Where a regulator has a number of functions, there is a greater possibility of those functions conflicting or competing for resources. And if they do (particularly with an expansion in economic regulation), who makes the decision on which takes priority? This is not just in respect of outcomes - if there is a limited budget available, which parts of the organisation take the lion’s share and which have to start reducing headcount? Unless there are strong controls on its functions and outputs, such an organisation can become unwieldy, expensive and lose focus.
The transfer of the safety function for the railways from the Health and Safety Executive to the ORR means the UK continues to maintain one of the safest railways in Europe. Having the safety expertise in one place works well, and the industry levy ensures that the funding goes to the right place. However, it could be argued that the safety regulatory function itself has not changed significantly from when HMRI was at the HSE, and moving to the ORR has been more of an administrative than a functional change.
Where the UK ends up on overlapping franchises is likely to be a key issue. This is likely to be a much bigger battleground than potential open access routes, with the opportunity for more on-track competition rather than just deciding who gets a seven to ten-year near monopoly.
But is regulation always a good thing? It depends on whether there is a “one size fits all” approach or whether the system can be finessed. Indeed, the light rail industry is keen to remain free from much of the regulatory impact of the ORR, such as looking to manage its own safety regulation through its own body (UK Tram). The intention here is for the solutions offered to be more attuned to the light rail sector, rather than importing more expensive (and sometimes inappropriate) heavy rail solutions.
One question that the article does not really address is the funding for the regulator. Any wider remit (or one continuing at the same level) is likely to require significant funding - and is the industry prepared to pay for that? If the industry is to be required to contribute more to support the ORR, to what extent does the regulator need to be regulated itself to ensure that it is being economic and efficient with its own resources and funding? Quis custodiet ipsos custodies - Who watches the watcher?
Regulation of the rail sector has always been complex, and arguably was made more so following the abolition of the Strategic Rail Authority.
The original rationale for two economic regulators in rail was to recognise that decisions on services to be provided by franchised passenger operators would affect subsidy. So matters such as minimum service requirements and fares policy were (from the start) the responsibility of the Office of Passenger Rail Franchising, although other consumer protection functions applying to all operators, such as timetable information and complaints handling, were given to ORR (which originally sponsored the passenger watchdog bodies). These functions were transferred to the SRA when that body was established. But when it was abolished, they were taken over by the Department - rather than being returned to ORR.
This has created a confusion about the role of the Department, which has only been made worse by the reclassification of Network Rail. It now exercises policy and strategy functions for the sector, acts as the procurer of passenger rail services, operates as an economic regulator in respect of fares and passenger service standards, and is responsible for shareholder functions in respect of Network Rail. This mix of functions is impossible to exercise effectively and without contradiction. The contradictions would be reduced if some of these functions were transferred to an independent regulator.
What of the argument that Government would lose control if ORR had more power? This argument misunderstands both the role of a regulator and the meaning of independence.
Ministers are rightly concerned to ensure that their legitimate policy and strategic objectives are achieved, efficiently and effectively. But that is precisely what regulators have been set up to do: to provide expert, transparent assurance - whether to consumers or citizens - that service providers are delivering the right outcomes and doing so efficiently. How those outcomes are achieved is part of the assurance process, to ensure that costs are not simply being deferred, or future service levels compromised. If that assurance can be given, that should be enough.
But what of the concern that an independent regulator might take a different view of the required outcomes? As John Swift, the first Rail Regulator, has put it in evidence to the House of Lords: “Independence of the regulator survives so long as, and only so long as, the actions of the regulator do not produce results which are at odds with what a democratic system expects.” In the specific case of rail, it manifestly ignores the HLOS and SoFA process enshrined in the Railways Act 2005.
Although the BIS principles of economic regulation only date from 2011, they are very similar to the principles developed by Ed Balls in respect of the Government’s role in macro-economic policy in 1997 (constrained discretion; credibility through sound, long-term policies; credibility through maximum transparency; credibility through pre-commitment). But the current Government has largely ignored these principles. This is not in the interests of consumers or taxpayers - and ultimately is not in the interests of government either.
Login to comment
Comments
No comments have been made yet.