UK: Rolling Stock Leasing: A Clean Bill Of Health For The ROSCOs?

An Indication That Change May Rest In The Government´s Hands
Last Updated: 3 September 2008
Article by David Aitman and Satyen Dhana

Summary

The Competition Commission has published its provisional findings in its inquiry into rolling stock leasing in the UK. It has provisionally found that certain aspects of the market give rise to competition concerns. Notably, though, it has found that these do not arise out of anti-competitive practices of the rolling stock operating companies. Instead, its provisional adverse findings are focused on the Department for Transport and how it controls the passenger franchising process. This briefing outlines the provisional findings and the Department for Transport's options.

The Competition Commission (CC) has published its provisional findings in its inquiry into rolling stock leasing in the UK. It has provisionally found that certain aspects of the UK rolling stock leasing market give rise to competition concerns. Notably, though, it has found that these do not arise out of anti-competitive practices of the rolling stock operating companies (ROSCOs). Instead, its provisional adverse findings are focused on the Department for Transport and how it controls the passenger franchising process. The CC seems minded to find that it is this process that limits the possibility of effective competition in rolling stock leasing.

The CC cannot impose remedies on the government, so here is limited to making recommendations to the Department for Transport and proposing a limited potential remedies package in relation to the ROSCOs. This is a very different provisional result from those in other recent market investigations carried out by the CC (for example, groceries), in which it has been able to take the lead on remedying any concerns that it found.

The government's reaction to the provisional findings (and any similar final recommendations formalised at the end of the inquiry next year) will have implications beyond the ROSCOs' businesses. Acceptance of the CC's recommendations will confirm the CC's ability to make recommendations that have at the very least persuasive effect as well as its ability to run effective and meaningful inquiries in regulated or semi-regulated sectors. A decision not to follow its recommendations would, conversely, raise questions about the point and effectiveness of inquiries in such sectors.

However, it is not clear what the government's reaction will be: while the recommendations are aimed at addressing competition concerns in the rolling stock leasing market, they do not appear to take account of the other effects on value for money in the rail industry as a whole. For example, longer franchises (suggested by the CC) may negatively affect the ability to secure full value from franchise bids based on revenue/ridership forecasts over a much longer period than at present. Also, longer incumbency in an operating concession may prompt greater complacency and less innovation, resulting in a negative effect on the passenger. Accordingly, the Department for Transport will have to perform a careful balancing act, ensuring that implementing the CC's recommendations does not damage other aspects of the rail industry.

Why the CC is concerned

The CC has provisionally found that certain 'features' of the UK rolling stock leasing market prevent, restrict or distort competition.

In particular, it has provisionally found that:

  • there is a shortage of rolling stock solutions available to the train operating companies (TOCs) when bidding for franchises;

  • competition can be negatively affected by the way the TOC franchising system interacts with the process for leasing rolling stock for franchised services;

  • ROSCOs, in many cases, have weakened incentives to compete on lease rentals of used rolling stock, particularly if they face little competition in supply from potential alternative fleets or if alternative fleets (of a particular type of rolling stock) are already fully deployed. Increasing demand for rail travel coupled with the Department for Transport's objective of ensuring that as much of the existing rolling stock as possible is in use play a key part in limiting ROSCOs' incentives to compete; and

  • barriers to entry into the market(s) for leasing rolling stock to franchised passenger services, whether entering using new or used rolling stock, are high.

Why the CC focused on the government and its Processes

Interestingly, few – if any – of these 'features' have resulted from practices carried out by the ROSCOs. Although the CC has concerns about the rental prices charged to TOCs for short-term leases, it did not find that the sector was characterised by excess profits or that it was rife with anti-competitive practices. Indeed, it found 'no evidence of co-ordination in pricing or market sharing' in relation to leasing new rolling stock. Further, it provisionally concluded that ROSCOs self-regulated release prices and 'took account of their obligations under their Code of Practice'.

Instead, the provisional findings focus on the Department for Transport's role and the (apparently negative) effect of the passenger franchise process on leasing rolling stock. The CC is quite clear that the Department for Transport plays the definitive role in the sector, stating that it 'does... have significant legislative and other powers to determine the overall shape of the market and influence rolling stock allocation and use'. It provisionally found that it was the franchising process – dictated by the Department for Transport – that was the main reason competition in leasing rolling stock was less than fully effective. The restrictive nature of franchises – specifying in detail rolling stock requirements and restrictions on TOCs' ability to use new rolling stock – limited the rivalry between ROSCOs.

The CC found little reason to seek remedies from ROSCOs, though. Specifically, it did not have any significant concerns about competition in leasing new rolling stock or the provision of maintenance services (areas examined by the Office of Rail Regulation in its referral decision). In these areas, the CC provisionally found that there was 'effective rivalry' between the ROSCOs and no regulatory action is necessary.

CC cannot dictate outcome: change is reliant on the Government

As the problems identified arise from the franchise process and the Department for Transport's role, the CC is restricted in what it can do to rectify the competition concerns arising from this inquiry. It has no power to instruct the Department for Transport to carry out any action and cannot effect changes to primary legislation.

Accordingly, in its notice on potential remedies, published at the same time as the provisional findings, the large majority of remedies take the form of recommendations to the Department for Transport and other third parties (the only action the CC itself considers is the possibility of price control on short-term leases). These recommendations are limited because they are in effect only observations on how the franchise process can be changed to stimulate greater competition between the ROSCOs. Any eventual action would require the Department for Transport to agree and 'buy in' to the changes, although it will be under no obligation to implement these recommendations.

This may be something of a test case for the CC and the government. Will the Department for Transport follow the CC's recommendations, bringing about changes to the rolling stock leasing market and confirming the importance of the CC's recommendations in regulated industry inquiries – particularly in circumstances where their recommendations may have negative as well as positive effects on the rail industry overall? Or will it decide not to do so, which would mean that little would change in the sector and the CC's ability to play a major role in regulated industry inquiries could be called into question?

All eyes will be on the Department for Transport.

For further information on infrastructure and transport from Freshfields click here.

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