05 Jul 2016

Brexit and the UK railways industry: So long and thanks for all the TSIs…

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23 June 2016: a day which will go down in history as the day Europe and the United Kingdom changed forever. The outcome of the European Union referendum saw 52% of the public vote in favour of leaving the EU. Since the "First Railway Package" of legislation was introduced in the early 1990s, the EU has had a significant impact on the funding, regulation and standards used on the railways throughout the UK. EU requirements have been implemented, to varying degrees, across Europe. The UK has been largely compliant, both in terms of the letter and spirit of those requirements, which have found their way into the heart of railway operations.

So what does "Brexit" mean for the UK railway industry? For franchises and franchising competitions, for rolling stock procurement, for key infrastructure projects? What legal and regulatory change are we likely to see? This is particularly in an environment where public finances are likely to be challenged through the effects of Brexit on the economy, where the UK could become a less attractive place to invest and where a predicted recession could lead to fewer jobs and less money in the pockets of passengers. In this article, we consider the implications of Brexit for the railways, both legally and the potential wider implications.

Status quo… for now 
It is worth making clear that, for the moment, the legal position post referendum has not changed. The law and regulation remains the same. Businesses should continue to comply with their obligations, whether arising from European or domestic law. Parliament will need to invoke Article 50 of the Treaty on the European Union, pass new legislation to repeal the European Communities Act 1972 and put in place transitional arrangements, making clear which "European" requirements will continue to apply.

European legislation has had a significant impact on laws in the UK (including on the railways) and the process to extricate the country from it will neither be easy or quick. There is a huge task to be done. Whilst some aspects of railway operations have their origins in European law (such as access to facilities, safety, licensing and TSIs) the core structure of railways regulation in the UK pre-dated European legislation (through the Railways Act 1993). There is also new European regulation ready to be enacted/adopted – in the recast of the First Railway Package and the implementation of the Fourth Railway Package which takes "separation" requirements further than previously. Whether these will be implemented in whole or in part is uncertain but at least, in the short term, these are likely to be adopted.

In due course, the government will have to tackle how to incorporate the European requirements it wishes to retain (if any) into domestic law as part of the untangling of the legal systems. The approach the government will take, and the resulting impact on rail businesses, remains to be seen. So for now, it's legal business as usual.

Train operations and franchising
The UK is likely to be seen as a different place to invest (particularly with its credit rating being downgraded) – and on home ground, government finances are likely to be challenged, with the economy predicted to be hit hard and the prospect of recession. This places rail in a difficult environment, with the potential for fewer passengers travelling (either for business or other discretionary travel). However, the government will be aiming to do what it can to deliver committed investment programmes to show the world that the UK remains open and an attractive place to invest despite its withdrawal from the EU.

In recent franchise competitions, we have seen "quality" aspects becoming more prominent when bids are assessed - the revised franchising programme seems to have brought quality and innovation back into the heart of rail, to the benefit of the passenger. Passengers and train operators alike will want quality will remain a key component of franchise bids. However, if there are pressures on public finances (as was the case in the last recession), it may be that quality loses its prominence and franchise bids as a result will become less ambitious from a quality perspective – with price being the overriding feature. Bidders may also wish to understand what (if any) protections may be available in the coming months from the government as it starts to understand the implications of Brexit.

Existing franchisees will also wish to review both their franchise agreement and their underlying sub-contracts to assess the impact of Brexit on their business (particularly if the franchise is operating on a low margin). Do protections in the franchise agreement help or mitigate the impact of any drop in revenue (for example revenue share/support or GDP reset mechanisms)? Will Brexit amount to a "Change" to the franchise and will a qualifying change in law arise due to law changes (this will depend on the definitions which are different across franchises). From a sub-contracting perspective, could there be gaps where the sub-contracts do not neatly fit with the franchise (and where protection could arise in one, but not the other)?

EU owned bidders may be concerned as to whether they would still be permitted to bid in UK franchise competitions and, likewise, UK based transport companies may be concerned whether they will be able to bid to operate in EU markets (particularly as they open to more competition). We consider it unlikely that the UK will close its doors to EU based companies in franchise competitions – particularly as the Department for Transport has been seeking to expand the bidders for its franchises for a number of years. Similarly, we also consider that experienced rail operators from the UK are unlikely to be excluded from competitions in the EU.

Separation of infrastructure from train operations
Theoretically, the withdrawal from the EU would remove the requirement for there to be separation between infrastructure management and train operations. Separation of operations from infrastructure has been a feature of Great Britain's railways since privatisation in the early 1990s, predating most European regulation, but the extent of that separation has become more heavily regulated by the EU. Could Brexit lead to a return to British Rail days, with both track and train being operated by the same company? Whilst this will depend upon the government of the day, with a long history of private companies investing significant sums in train operations (and other matters relating to the UK's withdrawal from the EU likely to be more pressing) it seems unlikely that this will be high up on the agenda in the post-Brexit world. There are also good competition, economic and commercial reasons for retaining the existing structure.

The UK also has an independent railways regulator in the ORR, regulating the terms of capacity allocation and charging to the railway network. Although the ORR's role has been refined by European legislation, we consider that these key roles of the ORR would not be changed as a result of Brexit and could become even more important if there is an element of vertical integration.

Rolling stock
With the value of sterling in the currency markets reducing, the rolling stock products of international manufacturers operating in euros are likely to become more expensive relative to domestic manufacturers. This could make new rolling stock generally more expensive. There may also be questions around whether additional tariffs or quotas will be introduced between the EU and the UK as trade deals are renegotiated. As government finances become tighter, the prospect of new rolling stock being procured through franchise competitions could be reduced. There may therefore be pressure on extending the life of existing rolling stock, particularly if good deals are offered on substantially enhanced vehicles.

Due to an expected liquidity squeeze arising in a potential Brexit recession (and uncertainty in the financial markets), traditional forms of rail financing based on debt may become more difficult or expensive. However, this may lead to opportunities for alternative financing solutions based on equity or bond based financing. We have seen an increase in the availability of such alternative financing solutions in recent years and although not many have reached financial close, Brexit could be the catalyst for change.

Infrastructure
Will Crossrail, Crossrail 2, HS2 and other rail projects still go ahead? Crossrail is at an advanced stage of development and investment and is unlikely to be affected by a Brexit; however, the same may not be the case for Crossrail 2 which is at a much earlier stage. Given the cross-party support which HS2 has, the work which has been done to date and the need for any government to be seen to be investing in infrastructure, there also seems to be a compelling case for HS2 to continue as planned. The same can be said for other large infrastructure projects, although we may see a slowdown of such projects to allow for funding over a longer period (particularly if it is being publicly financed). Investment by the government in infrastructure (including railways infrastructure) was a key feature of the last recession and helped to kick start the economy. Any government is likely to consider this as an option as part of the Brexit solution.

Ultimately, in order for the UK to function outside of the EU, an efficient transport network and additional capacity will still be required, which continues to provide a compelling case for many of the projects under development.

Uncertainty pervades at present – there is no clear direction on when or how the UK will withdraw from the EU – or the terms upon which it will happen. There will be winners and losers, including in the rail sector, as a result of Brexit. However, until there is clarity on the terms of the UK's exit from the EU, the UK legal and regulatory framework remains the same and provides a degree of certainty. Our view is that, for the moment, there are unlikely to be significant changes in the railways sector.

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Tammy Samuel

Tammy Samuel
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