Economic assessment of public service contracts. in the field of passenger transport. under application of Regulation 1370/2007

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1 30 OCTOBER 2012 Economic assessment of public service contracts in the field of passenger transport under application of Regulation 1370/2007 Views and recommendations from the public transport undertakings Introduction UITP (Union Internationale des Transports Publics) is the international organisation of public transport, it is based in Brussels and covers urban, suburban and regional public transport modes (bus, metro, light rail, regional rail and waterborne public transport). It gathers over members worldwide, public transport operators, their authorities and suppliers. In the European Union, the UITP EU Committee (EUC) represents the views of the public transport undertakings of the 27 member countries. It is closely following and participating in the elaboration of the different European policies and initiatives that have an impact on urban, suburban and regional public passenger transport. The UITP EUC has been following closely the decision-making of the European Commission after receiving complaints linked to transport contracts and in particular the recent decisions regarding the interpretation of reasonable profit. Due to the likely future market developments in Europe it is expected that the number of claims will be rising in the next years. Decisions 1, already taken by the European Commission (EC), were intensely and controversially discussed within UITP and with other stakeholders. The concerns expressed by the public transport professionals are relating to: 1. the chosen general assessment approach and the review periods 2. the retroactive application of regulation 1370/2007, 3. the definition of reasonable profit, 4. the risk allocation. The UITP EUC has collected the views of its members on these issues and wishes to share them with the EC. This paper summarises the concerns and views of the public transport sector and proposes a possible basis for guidelines for future decisions. 1 See Commission Decision of 24 February 2010 concerning public transport service contracts between the Danish Ministry of Transport and Danske Statsbaner (Case C 41/08 (ex NN 35/08)). OJEU 11 January 2011, p.1 Danish Public Transport Operators (DKT) submitted a formal complaint to DG TREN (since 2010 named DG MOVE) regarding alleged state aid granted (overcompensation) by the Danish Ministry of Transport to the Danish State railway (DSB) for the fulfillment of public service obligations based on so called negotiated contracts (non-tendered). In this decision, the European Commission defines the level of reasonable profit.

2 Preliminary remark: Possibility to include one or more profitable lines into a public service contract, In order to protect the necessary coherence and continuity of public transport networks and in order to limit the global cost of public transport services, the UITP EUC considers as absolutely fundamental that the possibility to establish a public service contract is not limited to nonprofitable transport services. Despite the possibility to include one or more profitable lines in a public service contract clearly proceeds from Regulation 1370/2007, the UITP EUC considers that this point remains too often subject to controversy. In the context of urban, suburban and regional public transport services, the UITP EUC therefore strongly welcomes the clarification provided by the EU Commission in the DSB case, especially in recitals (263) and (266): (263) The Commission thus points out that the specific legislation in force in no way limits the possibility of entrusting services missions covering a set of lines in order to establish a coherent transport system, particularly with the concern of allowing a certain continuity of transport. No criteria are laid down concerning the profitability or otherwise of the individual lines concerned. ( ). (266) The Commission therefore considers that Denmark is not committing a manifest error of assessment by including one or more profitable lines in a public transport service contract, in so far as those lines are part of a coherent transport system, and this irrespective of whether such lines already exist ( ). The Commission also notes that, if a line in that system were to be profit-making, the revenue from it should be taken into account in the overall calculation of costs and revenues related to the services concerned with a view to determining the level of compensation. It follows that the earnings from a profitable line would lead ultimately to a commensurate reduction in the financial compensation necessary in order to run the other, unprofitable lines in that system. In the absence of specific rules to the contrary, the Member State remains free to assess the scope of the public service that it wishes to entrust to an undertaking in order to establish an adequate transport system. 1) The chosen general assessment approach and the review periods Should the EC look at past or look at future cases? Would a focus on future cases only help? According to their own description the EC faces piles of complaints which are waiting for decision. This leads to long delays for new cases, which usually would need a quick decision. One solution might be a new priorisation of new and old cases and potentially the scratching of old cases. Of course the Members of the EUC are aware that the latter will be very difficult as formally launched procedures cannot be held up or stopped from one day to the other. Nevertheless, it seems necessary to develop a more efficient working structure enabling the European Commission to handle new incoming cases as quickly as possible without long delays. From the point of view of the EUC a natural cut appears to be the change the two regimes from 1191/69 to 1370/2007. All claims and cases regarding contracts closed after 3 December 2009, basing on alleged breaches of Regulation 1370/2007, should receive higher priority. The EC assessment approach: EX-ANTE, EX-POST? Are really both useful and appropriate? One of the key elements of concern is the approach to the assessment of contracts. In an ideal world contracts should be assessed EX-ANTE, i.e. after a tender or negotiation procedure and before the closure of a contract or before the contract comes to life. page 2

3 In most cases the EC is working EX-POST in the middle of or at the end of the contract period. The EX-POST approach implies a full review of all expenses and incomes during the lifetime of a contract. One of the major points that can be criticised is related to a monetary difference between assumed risks as well opportunities before contract closure and the real risks and opportunities encountered during and after the contract period. The EUC members noted a difference in the treatment of risks and opportunities by the EC: Over-compensation resulting from lower risks than estimated or unplanned external opportunities or synergies will be taken into account and may be subject to a recovery payment; Under-compensation resulting from higher risks than estimated or new obligations is not considered and will at the moment not lead to balancing payments from the public side to the operator. The different treatment of over- and under-compensation is leading to unjustified disadvantages. A possible solution could be found in the following approaches: 1. The application of the EX-ANTE principle in general only. To ensure accurateness of the calculation an independent accountant should after negotiation or tender and before contract closure assess the cost basis for the calculation handed in, making sure that all data assumptions are appropriate. The result will be the proof that the calculation has been produced on a sound basis. The EX-ANTE approach implies a general advantage as it offers a substantial incentive regarding the efficiency and quality of services, which an EX-POST evaluation would certainly prevent If an EX-POST evaluation is still desired, then it should be clearly indicated in the tender documents. In that case, a provision in the contract could safeguard that the notion of reasonable profit (and possible resulting over-compensation) will be kept, but also losses from unexpected risks would be compensated. Which time span of a contract should the EC review? Is a snapshot or the lifetime of a contract the right time span? In mid- and long-term contracts the profit margins will vary year-by-year due to the specific setup of the transport business. For example the start-up costs and costs from start-up problems will usually occur at the beginning of a contract period, i.e. profit margins will be low. Later the margins may be higher. The EUC recommends that in those cases where assessments of contracts are necessary the lifetime of a contract should be the assessment basis. Aggregation of loss-making and profit-making contracts? Should aggregation be considered as legal and does it create fair conditions? The example of the decision in case C41/2008 shows the Commission s acceptance of an aggregated review of different, legally separate transport service contracts when assessing reasonable profit. It is the view of the EUC that this approach is problematic, as it means that supernormal profits in one contract setting may be offset through less favourable profits or losses in other settings. Such aggregation may have widespread impact on the market framework. 2 Following the EU debate on legislation on Services of General Economic Interests (SGEI) also lead by Vice-President Almunia - it would be consistent to follow the path of EX-ANTE evaluation offering the incentive approach. page 3

4 For the EUC all contracts should be calculated separately as well as put to life and controlled separately. The general possibility to aggregate contracts in state aid assessments should be abandoned, as this creates the basis for unfair behaviour and distorts fair competition. Claw back mechanism in case of overcompensation Is dividend payment from a public entity to its public owner the right mechanism to avoid overcompensation? From the EC s decision in case C41/2008 one could read that proven overcompensation had effectively been regarded as paid back through dividends to the public shareholder. With regards to this decision the EUC has great concerns, as it sets the basis for the distortion of a fair market situation. Accepting the principle of paying-back overcompensation through dividends mixes up the role of the state as investor and as customer. It is important that the specific decision in case C41/2008 relates back to a special situation and will not become a common principle. It should remain normal practice that unlawful aid must be repaid inclusive of interest; see for example the Commission note regarding the role of national courts vis-à-vis the state aid rules (2009/C 85/01). 2) The retroactive application of Regulation 1370/07 Should the Public Service Regulation 1370/2007 apply retroactively? In the case C41/2008 the EC has explicitly applied Regulation 1370/2007 for contracts closed before 3 December 2009, the date when the regulation entered into force. This approach seems to be confirmed in the recent Decision of the Commission to initiate the formal investigation procedure in order to verify whether six restructuring measures in favour of the Greek state-owned railway company TRAINOSE are in line with EU state aid rules 3. This approach is quite astonishing as Reg. 1370/2007 does not foresee a retroactive application of its provisions. In addition, the retroactive application of 1370/2007 does interfere with existing contracts closed on a valid basis according to the rules under another regime. This approach cannot be supported by the UITP EUC as it stands in contradiction to Reg. 1370/2007 itself and creates a high level of uncertainty. 3) The definition of reasonable profit It is widely accepted that the business activity of public transport operators as it is the case for all other economic sectors - can be profit making. This applies for both privately held and publicly held companies. The EU in its legislation and jurisdiction has acknowledged this fact and compensation of public service contracts is intended to cover the costs incurred through the discharge of public service obligations, taking into account the revenue generated and a (reasonable) profit. However the EU legislation is making an important difference between - contracts awarded through an open and competitive tendering process: in this case it is assumed that market forces will fix the appropriate level of compensation (and profit) and - contracts awarded directly or services submitted to general rules: in this case, all compensation shall comply with the calculation method laid down in the Annex of 3 See Commission Decision of 13 July 2011, C (2011) 4943, OJ C272/2011, , recital (151) page 4

5 Regulation 1370/07. This includes the notion of reasonable profit, i.e. the profit must be reasonable within certain limits. Three years after the entry into force of Regulation 1370/07 it appears that the rules on defining the level of reasonable profit and the way of evaluation are not well-defined and leave more space open for interpretation than desirable. Is reasonable profit quantifiable? Over the past two years the Commission has asked several UITP members for their views on average levels of profit. The EUC strongly advises not to discuss or to fix a country by country profit level which should be regarded as the benchmark for reasonable profit. A reasonable profit level will always depend on a case-by-case review considering the business model as well as the opportunities and risks of a contract. Is the definition of reasonable profit in Reg. 1370/2007 applicable in all cases? The annex of Reg. 1370/2007 quotes that Reasonable profit must be taken to mean a rate of return on capital that is normal for the sector in a given Member State and that takes account of the risk, or absence of risk, incurred by the public service operator by virtue of public authority intervention. The definition of the rate of return on capital implies a range of evaluation criteria not only return on capital in its literal sense. In the economic theory there are plenty variants of rate of return on capital. Any criterion which can explain the rate of return on capital should be considered and it should be left to the parties concerned to decide which criterion is the most appropriate one. From the point of view of the UITP EU-Committee the choice of the most appropriate evaluation criterion should be depending on the given situation (contract details, contract type, ). This view is supported by the fact that Reg.1370/2007 does not give a special detailed method. Example: In the case when companies do not buy but lease their high value assets the literal application of the term would easily lead to a wrong picture when calculating and assessing the profit margins of contracts. Therefore it will be necessary to assume that the special financing model of leasing is adequately considered. 4) The risk allocation How should the EC consider risks and their allocation? Is there really a one-fits-all approach? The UITP EU-Committee Members were occasionally asked by the EC about their general views on risks and their potential quantification. The EUC clearly underlines that there never can be a one-fits-all approach for the quantification of risks. The level of risks varies a lot starting at zero going up to very high. The risks and their allocation depend on the conditions set in each individual contract page 5