Transport Report: Restructuring the Channel Tunnel link and the financing of Section 1
In 1996, London & Continental Railways Limited (LCR) was
awarded a concession from the UK Government under the private
finance initiative to build and operate the Channel Tunnel Rail
Link (CTRL) and to own and operate the European Passenger Service.
The sponsors of LCR include UBS Warburg, Bechtel Limited, National
Express Group plc, Systra?Sofretu-Soferail, London Electricity
Limited, Ove Arup & Partners Limited and Sir William Halcrow
Limited.
The CTRL consists of a 68 mile high-speed rail link between the Channel Tunnel and London's St. Pancras station. Upon completion it will greatly increase the capacity for international trains and reduce the journey time between London and each of Paris and Brussels by approximately 35 minutes.
The European Passenger Service which has since been renamed Eurostar (UK) Limited (EUKL), involves operation of the Eurostar train service between London and each of Paris and Brussels.
Unfortunately, prior to completion of the planned issuance of equity and debt by LCR to finance the construction of the CTRL, the Eurostar service experienced greater than anticipated losses. As a result, in January 1998, LCR requested an additional subsidy from the UK Government of approximately £1.2 billion. This request was rejected but the UK Government allowed LCR time to restructure its operations to facilitate the construction of the CTRL by the private sector.
By June 1998, LCR reached an agreement with Railtrack Group plc (Railtrack) and the Government to enable a restructured financing and construction of the CTRL. LCR also entered into a separate management agreement with a consortium consisting of, inter alia, British Airways plc, French Railways Limited, Société Nationale des Chemins de fer Belges and National Express Group plc for the operation of the Eurostar service until 2010. The remainder of this article will focus on the restructuring and financing of the construction of the CTRL.
Restructuring of LCR
The original concession awarded to LCR pursuant to the terms of a Development Agreement set out, inter alia, the terms upon which the CTRL must be designed, financed, constructed and maintained. The Development Agreement also outlined the level of public sector support to be provided by the Government.
As part of the restructuring of the CTRL project, LCR agreed to sell, and Railtrack agreed to purchase, part of the assets that will comprise the CTRL. Railtrack also agreed to assume the risk for construction cost overruns in relation to those assets. To accommodate this structure, the terms of the concession between LCR and the Government were amended and restated and the CTRL was split into two sections. Section 1 runs from the Channel Tunnel to Fawkham Junction and Section 2 runs from Southfleet to St. Pancras Station. The term of the concession was also reduced from 999 years to 100 years (from 1996).
To preserve the structure of the concession granted to LCR under the Development Agreement, LCR remained liable to the Government for completion of the CTRL. However, to facilitate splitting the CTRL into two sections, LCR entered into agreements with two newly incorporated companies which effectively resulted in the transfer of all assets (including all contractual and intellectual property rights) relating to Section 1 to Union Railways (South) Limited (URS) and the transfer of all assets (including all contractual and intellectual property rights) relating to Section 2 to Union Railways (North) Limited (URN).
The transfers included creation of various trusts by LCR in relation to rights to receive public sector support and compensation under the Development Agreement, and any non-assignable contract for the benefit of URS and URN, as applicable. In addition, all shared assets used for both Section 1 and Section 2 were transferred to URS to be held on trust for the benefit of itself and URN, as applicable.
Pursuant to the terms of the amended Development Agreement, LCR nominated URS and URN as subcontractors for the construction of Section 1 and Section 2, respectively. URS then entered into an agreement with Rail Link Engineering (RLE) for the project management, design and construction of Section 1 of the CTRL. URN will enter into a similar agreement with RLE in relation to Section 2. RLE is an unincorporated joint venture consisting of Bechtel Limited, Ove Arup & Partners Limited, Sir William Halcrow Limited and Systra-Sofretu-Soferail and was the entity originally nominated by LCR to construct the CTRL. RLE is strongly incentivised to complete Section 1 within the target cost estimate.
Services of personnel are provided to each of URS and URN through service agreements entered into with Union Railways Limited which was the company originally responsible for the design of the CTRL that was acquired by LCR in accordance with the terms of the original concession.
Railtrack (through a wholly owned subsidiary which is outside the scope of its existing infrastructure business) then entered into a purchase agreement with URS, to purchase all of the assets related to Section 1 at a date tied, except in specified circumstances, to the issue of the permit to use. The purchase price for Section 1 is based upon the cost of construction as adjusted to take into account payments of public sector support, interest costs and certain other receipts. Railtrack also assumed all responsibility with respect to cost overruns on Section 1 above a level which was agreed as the target cost estimate for construction plus 20%. Any amounts contributed by Railtrack by way of cost overruns will be set off against the ultimate purchase price for Section 1.
Since Railtrack is liable for cost overruns, Railtrack needed a mechanism to enable it to manage constructions costs. To accommodate this, Railtrack was given a special share in URS which entitles Railtrack to appoint the entire board of directors of URS. Railtrack also has certain veto rights in connection with its shareholding. Management arrangements are also contained in the purchase and sale agreement.
Railtrack has an option exercisable until July 2003 to purchase Section 2 upon terms similar to those agreed for the purchase of Section 1. Until Railtrack exercises its option, LCR remains liable for the financing and construction of Section 2.
In return for its investment Railtrack is entitled to receive access charge payments from EUKL for a period of 50 years. These access charge payments are guaranteed by the Government. The access charges are set at a level which enabled Railtrack to receive a return on its investment on Section 1. Railtrack has also entered into a revenue sharing arrangement with EUKL for the period 2004 to 2010 in relation to Section 1 such that the access charge payable to Railtrack during that period will be adjusted depending on whether actual revenues are greater or less than projected revenues. If Railtrack exercises the Section 2 option, the amount of the access charge payments is increased to provide Railtrack with an even greater return on its initial investment.
The Government also entered into a direct agreement with Railtrack, URS and URN which provides that upon termination of the Development Agreement with LCR, a direct concession will be entered into with URS or URN, as applicable, and upon purchase of the Section 1 or Section 2 assets or termination of the concession with URS or URN, Railtrack will be granted a direct concession.
With that very brief overview of the restructuring, this article will now examine the financing package assembled to permit construction of the CTRL.
Financing of Section 1
Despite the restructuring, LCR remains responsible for the financing of both Section 1 and Section 2 of the CTRL up to the point which Railtrack assumes cost overruns and until Railtrack purchases the relevant section. The financing for Section 1 is designed not only to cover the costs of construction of Section 1, but also facilitates preliminary works on Section 2, acquisition costs for the land for both Section 1 and Section 2 and EUKL expenses.
The financing for Section 1 has three principle sources ? government guaranteed bonds, public sector support and various debt facilities guaranteed by Railtrack.
As part of the restructuring arrangements, the Government agreed to guarantee up to £3.65 billion of bonds to be issued by LCR Finance plc, an affiliate of LCR. These monies effectively replaced and were a much cheaper source of funds than the planned equity issuance and project financing.
To date an aggregate of bonds worth £2.5 billion guaranteed by the Government have been issued (£1 billion payable 2010, £1.225 billion payable 2028 and £0.425 billion payable 2038). Proceeds of these bond issues are available to fund construction of Section 1, land acquisition costs and LCR's other working capital requirements including Eurostar losses and construction of Section 2. As security for its guarantee, the Government received a first charge over LCR's assets along with other companies within the LCR group and a second charge over the assets of LCR and URS already subject to a first charge in favour of Railtrack. These security arrangements are subject to a priority agreement between the Government and Railtrack.
The obligation of the Government to contribute public sector support is set forth in the Development Agreement. In relation to Section 1, public sector support consists of a capital grant in the amount of £778.1 million (in January 1997 prices) and a domestic capacity charge of £527 million (in January 1997 prices). The capital grant is payable in eight consecutive, quarterly instalments of equal amounts commencing on 15 November 2001 provided actual expenditure is at least equal to 68% of the value of the Section 1 target construction costs and based on identified construction milestones. The domestic capacity charge is payable by the Government to reserve domestic capacity. It is payable in 34 consecutive semi-annual instalments of equal amounts commencing the 78 months after financial close provided the permit to use has been issued in connection with Section 1.
Although these amounts are payable to LCR, they are ring-fenced from an LCR insolvency in accordance with the trust provisions described above. As well, these trust arrangements are supplemented with a financial direct agreement which provides for the Government to pay the public sector support monies directly into a URS security account which is subject to a fixed charge in favour of Railtrack. Withdrawals from this account may be made by URS only to fund costs in connection with Section 1.
The debt facilities guaranteed by Railtrack consist of three separate facilities as follows:
1. £350 million facility arranged by syndicate of commercial banks;
2. £150 million facility issued by Kreditanstalt für Wiederaufbau (KfW); and
3. £200 million facility issued by the European Investment Bank (EIB).
As a result of the Railtrack guarantee, these facilities are structured primarily as Railtrack corporate facilities and thus avoided the necessity for an expensive and complicated project financing.
The commercial bank facility and the KfW facility mature on the purchase by Railtrack of the Section 1 assets and certain fixed dates. The EIB facility is novated to Railtrack upon purchase by Railtrack of the Section 1 assets.
Although LCR is the borrower in relation to the above facilities, complex arrangements were entered into to ensure that upon any insolvency of LCR, all of the financing arrangements would novate to URS.
Railtrack is entitled to set-off payments it makes under its guarantee of the facilities against the purchase price payable for Section 1. Railtrack also has a counter indemnity from LCR and URS secured by a debenture ranking in first priority over all the assets of URS and a charge ranking first over certain assets of LCR. All advances under these facilities will be paid into the URS security account.
Financing of Section 2
Construction of Section 2 is scheduled to commence in 2001 and is expected to be completed in 2006. Financing of Section 2 will rely on an additional issuance of up to £1.1 billion of Government guaranteed bonds, the payment of deferred grants by the Government and the balance from commercial debt. The nature of financing of Section 2 will depend on whether Railtrack exercises its option to purchase the Section 2 assets. Railtrack has publicly stated that it does not expect to make a decision regarding the exercise of its Section 2 option until after its regulatory review which is scheduled to take place in 2000.
Conclusion
To date, construction on Section1 of the CTRL is proceeding on schedule and under budget and by all accounts it appears that the restructuring of Section 1 of the CTRL will be viewed as a success by all those involved. Hopefully this result will provide a positive framework for progress on Section 2 and the ultimate completion of the UK's first high-speed rail link.
The CTRL consists of a 68 mile high-speed rail link between the Channel Tunnel and London's St. Pancras station. Upon completion it will greatly increase the capacity for international trains and reduce the journey time between London and each of Paris and Brussels by approximately 35 minutes.
The European Passenger Service which has since been renamed Eurostar (UK) Limited (EUKL), involves operation of the Eurostar train service between London and each of Paris and Brussels.
Unfortunately, prior to completion of the planned issuance of equity and debt by LCR to finance the construction of the CTRL, the Eurostar service experienced greater than anticipated losses. As a result, in January 1998, LCR requested an additional subsidy from the UK Government of approximately £1.2 billion. This request was rejected but the UK Government allowed LCR time to restructure its operations to facilitate the construction of the CTRL by the private sector.
By June 1998, LCR reached an agreement with Railtrack Group plc (Railtrack) and the Government to enable a restructured financing and construction of the CTRL. LCR also entered into a separate management agreement with a consortium consisting of, inter alia, British Airways plc, French Railways Limited, Société Nationale des Chemins de fer Belges and National Express Group plc for the operation of the Eurostar service until 2010. The remainder of this article will focus on the restructuring and financing of the construction of the CTRL.
Restructuring of LCR
The original concession awarded to LCR pursuant to the terms of a Development Agreement set out, inter alia, the terms upon which the CTRL must be designed, financed, constructed and maintained. The Development Agreement also outlined the level of public sector support to be provided by the Government.
As part of the restructuring of the CTRL project, LCR agreed to sell, and Railtrack agreed to purchase, part of the assets that will comprise the CTRL. Railtrack also agreed to assume the risk for construction cost overruns in relation to those assets. To accommodate this structure, the terms of the concession between LCR and the Government were amended and restated and the CTRL was split into two sections. Section 1 runs from the Channel Tunnel to Fawkham Junction and Section 2 runs from Southfleet to St. Pancras Station. The term of the concession was also reduced from 999 years to 100 years (from 1996).
To preserve the structure of the concession granted to LCR under the Development Agreement, LCR remained liable to the Government for completion of the CTRL. However, to facilitate splitting the CTRL into two sections, LCR entered into agreements with two newly incorporated companies which effectively resulted in the transfer of all assets (including all contractual and intellectual property rights) relating to Section 1 to Union Railways (South) Limited (URS) and the transfer of all assets (including all contractual and intellectual property rights) relating to Section 2 to Union Railways (North) Limited (URN).
The transfers included creation of various trusts by LCR in relation to rights to receive public sector support and compensation under the Development Agreement, and any non-assignable contract for the benefit of URS and URN, as applicable. In addition, all shared assets used for both Section 1 and Section 2 were transferred to URS to be held on trust for the benefit of itself and URN, as applicable.
Pursuant to the terms of the amended Development Agreement, LCR nominated URS and URN as subcontractors for the construction of Section 1 and Section 2, respectively. URS then entered into an agreement with Rail Link Engineering (RLE) for the project management, design and construction of Section 1 of the CTRL. URN will enter into a similar agreement with RLE in relation to Section 2. RLE is an unincorporated joint venture consisting of Bechtel Limited, Ove Arup & Partners Limited, Sir William Halcrow Limited and Systra-Sofretu-Soferail and was the entity originally nominated by LCR to construct the CTRL. RLE is strongly incentivised to complete Section 1 within the target cost estimate.
Services of personnel are provided to each of URS and URN through service agreements entered into with Union Railways Limited which was the company originally responsible for the design of the CTRL that was acquired by LCR in accordance with the terms of the original concession.
Railtrack (through a wholly owned subsidiary which is outside the scope of its existing infrastructure business) then entered into a purchase agreement with URS, to purchase all of the assets related to Section 1 at a date tied, except in specified circumstances, to the issue of the permit to use. The purchase price for Section 1 is based upon the cost of construction as adjusted to take into account payments of public sector support, interest costs and certain other receipts. Railtrack also assumed all responsibility with respect to cost overruns on Section 1 above a level which was agreed as the target cost estimate for construction plus 20%. Any amounts contributed by Railtrack by way of cost overruns will be set off against the ultimate purchase price for Section 1.
Since Railtrack is liable for cost overruns, Railtrack needed a mechanism to enable it to manage constructions costs. To accommodate this, Railtrack was given a special share in URS which entitles Railtrack to appoint the entire board of directors of URS. Railtrack also has certain veto rights in connection with its shareholding. Management arrangements are also contained in the purchase and sale agreement.
Railtrack has an option exercisable until July 2003 to purchase Section 2 upon terms similar to those agreed for the purchase of Section 1. Until Railtrack exercises its option, LCR remains liable for the financing and construction of Section 2.
In return for its investment Railtrack is entitled to receive access charge payments from EUKL for a period of 50 years. These access charge payments are guaranteed by the Government. The access charges are set at a level which enabled Railtrack to receive a return on its investment on Section 1. Railtrack has also entered into a revenue sharing arrangement with EUKL for the period 2004 to 2010 in relation to Section 1 such that the access charge payable to Railtrack during that period will be adjusted depending on whether actual revenues are greater or less than projected revenues. If Railtrack exercises the Section 2 option, the amount of the access charge payments is increased to provide Railtrack with an even greater return on its initial investment.
The Government also entered into a direct agreement with Railtrack, URS and URN which provides that upon termination of the Development Agreement with LCR, a direct concession will be entered into with URS or URN, as applicable, and upon purchase of the Section 1 or Section 2 assets or termination of the concession with URS or URN, Railtrack will be granted a direct concession.
With that very brief overview of the restructuring, this article will now examine the financing package assembled to permit construction of the CTRL.
Financing of Section 1
Despite the restructuring, LCR remains responsible for the financing of both Section 1 and Section 2 of the CTRL up to the point which Railtrack assumes cost overruns and until Railtrack purchases the relevant section. The financing for Section 1 is designed not only to cover the costs of construction of Section 1, but also facilitates preliminary works on Section 2, acquisition costs for the land for both Section 1 and Section 2 and EUKL expenses.
The financing for Section 1 has three principle sources ? government guaranteed bonds, public sector support and various debt facilities guaranteed by Railtrack.
As part of the restructuring arrangements, the Government agreed to guarantee up to £3.65 billion of bonds to be issued by LCR Finance plc, an affiliate of LCR. These monies effectively replaced and were a much cheaper source of funds than the planned equity issuance and project financing.
To date an aggregate of bonds worth £2.5 billion guaranteed by the Government have been issued (£1 billion payable 2010, £1.225 billion payable 2028 and £0.425 billion payable 2038). Proceeds of these bond issues are available to fund construction of Section 1, land acquisition costs and LCR's other working capital requirements including Eurostar losses and construction of Section 2. As security for its guarantee, the Government received a first charge over LCR's assets along with other companies within the LCR group and a second charge over the assets of LCR and URS already subject to a first charge in favour of Railtrack. These security arrangements are subject to a priority agreement between the Government and Railtrack.
The obligation of the Government to contribute public sector support is set forth in the Development Agreement. In relation to Section 1, public sector support consists of a capital grant in the amount of £778.1 million (in January 1997 prices) and a domestic capacity charge of £527 million (in January 1997 prices). The capital grant is payable in eight consecutive, quarterly instalments of equal amounts commencing on 15 November 2001 provided actual expenditure is at least equal to 68% of the value of the Section 1 target construction costs and based on identified construction milestones. The domestic capacity charge is payable by the Government to reserve domestic capacity. It is payable in 34 consecutive semi-annual instalments of equal amounts commencing the 78 months after financial close provided the permit to use has been issued in connection with Section 1.
Although these amounts are payable to LCR, they are ring-fenced from an LCR insolvency in accordance with the trust provisions described above. As well, these trust arrangements are supplemented with a financial direct agreement which provides for the Government to pay the public sector support monies directly into a URS security account which is subject to a fixed charge in favour of Railtrack. Withdrawals from this account may be made by URS only to fund costs in connection with Section 1.
The debt facilities guaranteed by Railtrack consist of three separate facilities as follows:
1. £350 million facility arranged by syndicate of commercial banks;
2. £150 million facility issued by Kreditanstalt für Wiederaufbau (KfW); and
3. £200 million facility issued by the European Investment Bank (EIB).
As a result of the Railtrack guarantee, these facilities are structured primarily as Railtrack corporate facilities and thus avoided the necessity for an expensive and complicated project financing.
The commercial bank facility and the KfW facility mature on the purchase by Railtrack of the Section 1 assets and certain fixed dates. The EIB facility is novated to Railtrack upon purchase by Railtrack of the Section 1 assets.
Although LCR is the borrower in relation to the above facilities, complex arrangements were entered into to ensure that upon any insolvency of LCR, all of the financing arrangements would novate to URS.
Railtrack is entitled to set-off payments it makes under its guarantee of the facilities against the purchase price payable for Section 1. Railtrack also has a counter indemnity from LCR and URS secured by a debenture ranking in first priority over all the assets of URS and a charge ranking first over certain assets of LCR. All advances under these facilities will be paid into the URS security account.
Financing of Section 2
Construction of Section 2 is scheduled to commence in 2001 and is expected to be completed in 2006. Financing of Section 2 will rely on an additional issuance of up to £1.1 billion of Government guaranteed bonds, the payment of deferred grants by the Government and the balance from commercial debt. The nature of financing of Section 2 will depend on whether Railtrack exercises its option to purchase the Section 2 assets. Railtrack has publicly stated that it does not expect to make a decision regarding the exercise of its Section 2 option until after its regulatory review which is scheduled to take place in 2000.
Conclusion
To date, construction on Section1 of the CTRL is proceeding on schedule and under budget and by all accounts it appears that the restructuring of Section 1 of the CTRL will be viewed as a success by all those involved. Hopefully this result will provide a positive framework for progress on Section 2 and the ultimate completion of the UK's first high-speed rail link.
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