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I open the 18th meeting in 2005 of the Local Government and Transport Committee. I have received apologies from Michael McMahon and I believe that Tommy Sheridan wishes to express his apologies for some future meetings.
I apologise for the fact that I will miss the next five meetings because of the birth of my first child—I am going to take the month of June to learn how to be a father. I am sure that I will be contacting members such as the convener and Paul Martin so that they can give me advice.
I speak on behalf of the whole committee when I wish you, your wife Gail and your forthcoming baby all the very best in the next few weeks. I am sure that it will take you a lot longer than a month to learn everything about being a father. Everybody's good thoughts and best wishes are with you.
I will give a brief introduction to the paper, which examines the rationale behind, and the risks of, competitive tendering. The paper started out using Caledonian MacBrayne as a case study, although the CalMac case has since become more central to it, and it uses the 300-plus responses to the first two consultations on competitive tendering as its main source, as well as subsequent discussions. It examines in particular the extent to which the Executive's plans for tendering address the concerns of consultees and reflect the lessons that have been learned from tendering in other sectors.
Thank you for those introductory remarks.
Thank you, Dr Bennett, for coming along and giving evidence. You said that the Executive designed the tender process quite well, but your paper asks fundamental questions about what the process is about. Is it about efficiency gains, innovation or improved services? I hear what you are saying generally, but will you say more about why, in your view, tensions exist between those areas? Will you also expand on what I thought was your implied criticism of the tender process not being able to deliver an improved service? Is the issue more about where we are now and how we can protect what we have got, rather than asking the islanders how they can get better delivery of services in the future?
I certainly agree that there are unlikely to be any benefits coming from the tender process. If you have read my paper, you will know that I found it difficult to come up with reasons to support the tendering process on the basis of the Clyde and Hebrides case. To write the section on the potential advantages of tendering, I had to look to examples of tenders in other sectors and the theory about tendering. It is telling that almost the only justification for tendering has been that it is necessary in order to comply with European law. I do not denigrate that as a reason, because, if it is the case—which I dispute—it is not unimportant. Nevertheless, it does not sell the case for tendering in terms of the economic and social benefits that might accrue. It is telling that neither the Executive nor the Commission has been able to come up with positive reasons why tendering is beneficial.
Goodness—on the basis of that answer I could ask hundreds of questions, but I will try to restrict myself, convener.
Can I deal with that last point first?
Sure.
The vesco is not an operator of last resort but the owner of the assets.
Okay. Sorry. You are right about the terminology.
It is intended to be the owner of the assets. If the tendering goes ahead, the operating company will be required to use the ships.
You suggest that there are other avenues through which non-discrimination might be demonstrated. Can you tell us more?
That might be done by coming up with a transparent method of proving that there is no overcompensation, which is one of the conditions in the Altmark judgment. Neil Kay proposed a mechanism that would go beyond the requirements of Altmark by establishing a non-profit operation, which would more than cover the bases.
I could ask many more questions, but I should let my colleagues in. I will come in again later, if the convener does not mind.
No problem.
First, there is no guarantee that the tendering exercise would result in savings to the Executive. If there were savings and the political will existed to reinvest the money in lower fares, in theory that could happen at the next tender. The most recent documents from the Executive contain a new provision whereby change might be able to be negotiated during a contract—that is untested, but the provision means that a contract could be improved.
I have many questions of my own but, like Bruce Crawford, I will allow other colleagues to come in.
I think that we are all in the same boat: there are a thousand questions flying around in my brain.
If tendering is required, the tender must be awarded on a lowest-cost basis. That is potentially a spur towards greater efficiency, but there is no guarantee, even if there is greater efficiency—and I have doubts about whether there will be—that it will benefit service users. The only costs that will be saved are those relating to the subsidy.
If we look at the matter from the perspective of the Executive considering lifeline services and possible improvements to them—and given that the Executive has to abide by European rules—how can it achieve what it wants and still keep within those European rules without adopting this particular model?
Sorry—could you rephrase that?
The Executive wants to maintain lifeline services. That is the whole purpose of the exercise. Presumably, it wants to improve those services and there is great demand from the people on the islands for all sorts of other things to help the economy, to provide better access to health services and so on. Given that the Executive is bound by the European rules, is there any other model that it could have come up with that would have dealt with everything, or that would have allowed us to tick all the boxes for the purposes of the Executive, the EU and communities? Is there any other way of doing things as far as you can see?
One should distinguish the way in which services are specified from the way in which they are implemented. Regardless of whether the Executive goes down the tendering route, the option is open to it, if it has the political will and the money, to improve the service specification. The biggest demand is for increasing the frequency of services, after which is the desire to reduce costs. It may be possible for those factors to be specified in a public service obligation. There is then the question whether to go to tender or not. The Executive needs to be satisfied that it is not overcompensating the operator for fulfilling those public service obligations, whatever they happen to be.
You are hinting that each route should be subject to a separate set of documents and cost criteria, although I did not see that proposal detailed in your submission. If the boats are rented from the vesco—or whatever we call it—at a set price, where are the variance opportunities to allow for cost benefit?
Do you mean for a company to lower its bid or to improve its profit once it has the services?
The latter.
The evidence from other tenders is that the most obvious way of making cost savings is by trying to renegotiate the labour force's terms and conditions and even, potentially, employing lower-cost labour. That has happened on almost every other ferry service throughout the United Kingdom. The labour force will bear the brunt of cost savings. The more qualitative dimensions, which cannot be specified in a contract, might also suffer. By and large, however, the contract deals comprehensively with service quality, although it cannot cover every base. The costs of labour and labour efficiencies provide the potential for savings. The most recent consultation documents pretty much acknowledged that there were limits to the protection that the Executive could afford to give.
Before I ask my main question, I will follow up on that important point. You are saying that, if we opt for tendering based on the lowest cost, it is most likely that the labour costs would make the difference between a lower-cost tender and a higher-cost one. To follow the logic of that, would there not then be a greater likelihood that a company with workers from outwith the UK would be able to submit a lower-cost tender?
The Executive has said that the Transfer of Undertakings (Protection of Employment) Regulations will apply or that, if they do not apply, it will recoup the costs, so the concern is more what would happen if a company bids a bit optimistically and finds that it has economic pressures after the tender has been accepted. TUPE does not protect the workforce indefinitely; it transfers rights and obligations at the moment of transfer but, under a six-year contract, there is ample time for terms and conditions to be renegotiated. Even though the redundancy liabilities would transfer to the new operator, it is possible that the company could replace workers and make cost savings in a six-year period, even if it had to make a redundancy payment. That is the most extreme example but, even if things did not go that far, there would still be time to renegotiate terms and conditions, numbers of employees and working hours.
Are there any other examples?
I have not studied tendering examples in enough depth. However, if you go round ferry services on the coast of the UK—including services between Scotland and Northern Ireland—you will notice that many of the crew have been replaced by workers from overseas, including from elsewhere in the EU.
Can I ask the question that I was going to ask—
I just want to ask a supplementary on that point. I understand your point about the protection that TUPE provides the workforce and the fact that any company that comes in could try to renegotiate terms. What has been the degree of unionisation in the companies that you mentioned? Obviously, CalMac has a high degree of unionisation. If a new company intended significantly to alter staff conditions or to reduce staff numbers, there could be industrial action, which itself would cause the successful tenderer financial problems.
That represents another disincentive to an operator. However, three years ago, in order to save costs, P&O replaced most of the non-officer staff on its routes between Portsmouth and France, which are about to be discontinued, with Portuguese workers. Although those ships were heavily unionised, the measure went through without that much industrial action. That said, I take your point that considerable industrial action would result if such a strategy were adopted.
I am sorry for interrupting your question, Dr Jackson.
That is fine. You raised an important point.
It is important to remember that the regulation was intended to bring shipping—in this case, coastal shipping—in line with major elements of the treaty of Rome. Most of the regulation centres on the freedom to provide services but, with article 4, the Commission is basically saying that, although it has removed legal barriers to operators from other countries operating ferry services in another member state, it does not want countries to get round that by imposing public service obligations on everyone, which makes routes unprofitable, and then subsidising only their own operators.
Colleagues have already asked several of my questions. What might be the consequences if the Executive does not put the routes out to competitive tendering? On page 9 or 10 of your paper, you say that the Commission rejects outright only a small number of state-aid cases, although it might decide to change the aid or some other action might be taken. The suggestion is that there might be another way forward than outright refusal. Will you expand on that point?
The Commission rejects only 1 or 2 per cent of cases and most do not reach that stage. There is a risk, in the medium term, if the Commission remains unhappy with what we are doing. If its interpretation of the cabotage regulation differed from what the Scottish Executive did, there would be the risk of legal proceedings against the Executive. That is why it is important to get a negotiated solution. The arguments could be tested in court, but that would be a lengthy and expensive process.
You said that 1 per cent of cases have been rejected by the Commission. Do you know what happened in those situations? Did they all end up in court or was a solution eventually found?
I do not know. The information comes from European law textbooks; I do not know the detail of the cases. Some cases will go to court, whereas others will be rejected by the Commission and renegotiated without legal proceedings being initiated.
My question relates to Margaret Smith's questions. We have the maritime cabotage regulation and underneath that we have EU guidance notes. A guidance note was issued in 1992 and a new guidance note on the need to tender or not, on the basis that Margaret Smith described, was issued in 2004. What is your understanding of the new 2004 guidance note? From your evidence and from what Margaret Smith has said, I understand that that guidance does not require that tendering take place.
The notes that you mention are Community guidelines on state aid to maritime transport. They do not deal solely with the cabotage regulation; they also deal with other situations in the maritime industry. It is true that, although the 1997 guidelines referred to tendering—they allowed exceptions in certain circumstances—tendering is not mentioned in the 2004 guidelines. However, a couple of months before the new guidelines were written, the Commission produced not guidelines but a communication on its interpretation of the cabotage rule. That communication of December 2003 went into considerable detail and states that, in principle, tendering is the best way to ensure non-discrimination. It also makes an exception, for the first time, for routes that carry fewer than 100,000 passengers a year; however, that would by no means cover all CalMac services. That communication is just the Commission's interpretation of the law.
In other words, it is as clear as mud.
Can I ask for clarification of the date that you mentioned? You mentioned July, but which year did you mean?
Sorry, this is a draft directive—
So, it is this July.
The directive will be signed this July if it is approved. It is not clear what stage the directive is at, but the aim, initially, was to have it approved before the end of July.
So, we now have guidance, the regulation and another layer—notes—that try to explain the cabotage regulation. We have layer upon layer of different argument.
Each of those layers carries different weight in law. A communication is the Commission's interpretation of the law, but a directive has more weight.
I understand.
Fergus, do you want to ask about this point?
I want to follow up Margaret Smith's points.
I will bring in Tommy Sheridan first, in that case.
Dr Bennett's paper is informative, detailed and, at points, complicated. We are dealing with a lifeline service for thousands of people and a company that employs more than 1,000 people. Is it your considered opinion that the competitive tendering route that the Executive seemed to be determined to pursue was the most productive route for the public in terms of value for money, given your experience of other examples? Has the Executive done all that it could to avoid competitive tendering or did it set off from the position that it had to have competitive tendering?
Obviously, I do not have an insight into everything that has gone on in the Executive. When the proposals were first announced back in 2000 or so, the Executive was quite clear that competitive tendering was required. The debate has moved on since then because of the Altmark ruling. However, I am not privy to information regarding whether other avenues were explored.
On page 8 of your submission, after talking about the four conditions that were attached to the Altmark judgment, you state:
It is fair to say that the Altmark case clarified the law, although it did not rewrite it. It has had major implications for a lot of European Union legislation. Technically, it did not change the law, but it has changed the way in which the law is interpreted in quite a few sectors.
You made the interesting comment that the original purpose behind the cabotage regulation was to make the situation less, not more, restrictive. However, the irony seems to be that, on this occasion, the cabotage regulation is being used to suggest that the Executive has less room for manoeuvre. Your evidence is that, as long as the public service obligation is clear and transparent, that is a viable legal route for the Executive to use in the matter.
It is certainly a legal route that is worth trying, although the Commission may well disagree with that interpretation—it may say that one can still discriminate even if one is not overcompensating. I disagree with that and I do not think that it is a plausible argument, but it is nevertheless one that the Commission might come up with.
To me, that is the crux of the matter. The Executive tells us that there are enormous consequences of its falling foul of the Commission legally. We need academics such as you to give us a strong backbone. If the Executive ensured that the subsidy to CalMac was proportionate, transparent and therefore legal, in your academic experience and from your reading of previous case law, what would be the chances that the Commission would take legal action against the Executive? We hope that it will not do so but, given that the Executive tells us that it is frightened that the Commission will do so, we need guys such as you to give us a bit of backbone.
There are two circumstances in which the European Commission might take legal action. One would be if, after all the negotiations were finished, it was still not happy with any of the proposals that were on the table. However, before we get to that stage, there is a lot of work to do to develop the proposals. For example, we need to add flesh to Neil Kay's proposal and work out a practical proposal under which we can show that there will not be overcompensation.
Would it be fair to say that the Executive's approach of saying that we must ask the European Commission's permission for the policy that we pursue in relation to the provision of lifeline ferry services for the islands is akin to inviting the Celtic manager to referee an old firm game in that it involves a misconception of roles? Do you agree that it is the responsibility of the Scottish Executive to propose a scheme? The European Commission's role really comes in after consultation, to assess whether that scheme complies with the legal framework.
I agree that it is the European Commission's role to give guidance and the Commission is clear that it would prefer the competitive tendering route to be taken. It stated in its 2003 communication that it believes that competitive tendering is, in principle, the best way to ensure non-discrimination. If the Executive wants to argue something different, it is incumbent on the Executive to come up with an alternative proposal. That is not to say that the Commission should not be involved in giving guidance but, if it prefers tendering, there is no reason to assume that it will come up with an alternative proposal for us.
To put it another way, if we ask the Commission, "Do we have to go out to tender?" the Commission will not say, "No, you don't." It will not do the Executive's job for it. We cannot really expect the Commission to say tendering is not necessary.
No. If you want to do something other than tender, it is for us or for the Executive to come up with an alternative proposal. It helps to have guidance from the Commission while doing that, but—
When I applied the football manager analogy to the Commission, in the interests of balance I should have said that it would be a bit like expecting the Commission to be the Celtic or Rangers manager, rather than attributing any particular bias to the Commission. It is not the Commission's role to come up with a scheme; it is the role of the Executive, after consultation with the Commission.
I think so.
Secondly—perhaps this is to play devil's advocate with your conclusions, but in a way that is, I hope, helpful to the argument—there seems to be an undercurrent that the aim of EU law in requiring competitive tendering is to secure the cheapest option—cheapest is best. That is perhaps implicit, if not explicit, in your conclusions. That is not a criticism of those conclusions per se. Am I right in saying that EU law permits two types of criteria governing the decision that must be taken in public procurement contracts? Those are set out in article 30 of 93/37/EEC.
The advice from the Commission and what has been stated by the Executive are that it is possible to assess a tender only on the lowest-cost basis, and it is for the Executive to specify dimensions such as quality. Once that has been set, assessment of the bids can be done only on the lowest-cost basis.
I understand that. I hope that we will have the chance to take evidence from the minister, civil servants and perhaps others from the EU later on. After all, this is an EU process: European Commission input to this Parliament is, perhaps, overdue, but in that way we could find out what it is saying.
That is right. That power exists if the bid is thought to be unrealistic in terms of meeting public service obligations. Bids must be realistic.
So that power exists. The tender's being economically advantageous as an alternative criterion could be another route. I mention that not because I am advocating tendering—I am not—but to point out that if there is tendering and if it is possible for CalMac to be appointed, even if it does not put in the lowest price, all that would have happened is that we would have undergone a hugely expensive process just to maintain the status quo.
That is a possible scenario.
I want to ask about a matter that you have touched on and to which Margaret Smith alluded: the consequences of breaking the rules, with particular reference to Trasmed. I understand that Trasmed was, like CalMac, a state-owned ferry company, which provided lifeline ferry services to the Spanish island communities. It failed to consult the Commission on its particular arrangements. You were good enough to correspond with me back in January to explain some of the background in that case. Following the Executive's defeat in December on tendering, I lodged a series of questions to Nicol Stephen, the Minister for Transport. One of them, S2W-13269, asked about what costs would be incurred as the result of any failure to tender the Clyde and Hebrides ferry services. In his answer, Nicol Stephen painted a very bleak picture of the dire consequences that would ensue all round. I will put to you parts of the answer. I will inevitably have to read from the answer selectively because it is quite long. He stated:
Aid was not suspended, although all that is in the answer is true. The Commission initially said that it wanted the aid to be suspended, but there is a provision—in the cabotage regulation itself, I think—for emergency funding of services. The Spanish Government's argument was that if it suspended aid, the services would stop, so it had to keep providing it. The Commission relented and allowed Spain to continue the funding.
Right. So, as the Minister for Transport told Parliament, the Commission required aid to be suspended. In fact, it was not suspended because Spain said that it could not do so
The Commission issued a requirement that Spain should suspend aid.
Yes, but, in practice, the aid was not suspended.
No, not to my understanding. The aid had to continue.
That is the point that I am trying to draw out. Following the investigation,
Not to my knowledge.
Nothing was paid back by Trasmed or the Spanish Government. Is that right?
There was a court case about the matter; I think that it was in 2001. In order to avoid the aid being reclaimed, Spain had to prove that there was no overcompensation, which it did.
Right. The point that I am making is that, although the minister painted the bleak picture that aid was required to be suspended and that Spain broke the rules, what happened was that neither Spain nor Trasmed paid back a penny piece. Nobody paid back anything—there was no penalty, sanction or consequence.
There is a difficulty there. It is true that, in the Trasmed case, Spain did not have to refund the payments. However, the difference is that the Spanish Government was committed to going down the tendering road. Three years later, it issued a renewed tender. The case does not show that a country can ignore ad infinitum what the Commission tells it to do. That said, the case shows that, in practice, the Commission is unlikely—certainly, in the short term—to demand complete and sudden cessation of services. For all sorts of reasons, it would be mad to do so. There are provisions in the cabotage regulation that allow the emergency aid to continue, at least temporarily. Nevertheless, that does not mean that a country can ignore ad infinitum what the Commission tells it to do. At some point, it will have to come to an agreement with the Commission.
I have two points to raise that follow on from Fergus Ewing's line of questioning. The CalMac situation is not similar to the Trasmed situation. As I understand it, Trasmed went through a tendering process that was deemed to be flawed. I understand that we have not gone through a tendering situation yet. Is that correct? I also understand that the ultimate outcome of the Trasmed case is that the service is now tendered. Is that the case?
Yes. Both those points are correct. The problem with the initial tendering process was that the Spanish Government gave 16 days in which companies had to compile tenders, which was not long enough, for obvious reasons. That is why the process was initially flawed. Spain was already committed to going down the tendering route. It ran one exercise that was incorrect, and then ran another three years later. In the legal proceedings that I have seen, the debate about whether or not the Government had to tender did not actually arise; it was a case of whether or not it should tender properly. The reason that I raised the issue was not to do with complying with European laws or with what the consequences might be; I raised it simply as a practical example of a case in which compensation has been shown not to be overcompensation in a shipping cabotage situation, albeit for a limited period of time. That practical example might inform this case.
If the Executive is, as it appears to be, so concerned about being open and transparent in its tendering process, and if the vesco will simply become a leasing company, why did not the Executive go for an open tender so that people could simply choose where they might lease a vessel from? I appreciate that they are quite specialist vessels, and it might be that somebody would want to lease some of them. However, why, in your view, did the Government not go for a completely open tendering system, given that, in theory, it is going to set up a separate company, in which it will own the shares, to lease vessels?
There were various reasons. One reason was that it was thought that, under European law, when the routes were bundled together, there would be quite a large tender. If it was going to be the responsibility of the operator to come in and provide vessels, that could be seen as a barrier to entry, because you have to be quite a big operator to provide 30-odd ships. If the requirement is simply to lease the ships, that opens up the tender to more competition.
Railway companies lease rolling stock, which tends to go with the tender. Lots of vehicles are rented rather than owned as far as transport in general is concerned—company cars, for example. On openness, where is the competition in the part of the tender that stipulates that vessels must be leased from the vesco, or whatever the new leasing company is going to be called?
As far as I understand the tender, there is nothing to prevent the new operators from bringing in ships in addition to those provided by the vesco, should they want to.
Is there anything that you know of in European regulations or notes—whatever you want to call them—that would interfere with the leasing arrangements for those vessels if they have to be leased by an operator? I presume that someone outside the UK could lease out vessels that might do the same job at a more competitive rate.
As far as I know, the Commission has not objected to an obligation to lease the vessels from the vesco being part of the tender.
Many of the CalMac vessels are very large and expensive and need a long in-commission period when they are new. Are the tendering process and the arrangements that have been agreed by the Executive robust enough for a proper discussion to take place between the vesco and the operator, whether it is CalMac or someone else, about a replacement programme? Is the process robust enough to allow agreement of a change in leasing arrangements?
Responsibility for new investment will lie with the publicly owned vesco. At the very least, the vesco will be able to slot in new ships when the tenders are renewed every six years. However, in the latest version of the draft tender document, provision is made for the Executive to negotiate with the operator to introduce new ships or change service frequency during the six-year period. The Executive intends to do that on a no-win, no-lose basis for the operator—there would be no financial gain or penalty for the operator. That could solve the problem, but I do not know how it will work in practice.
If the Executive was trying to secure additional efficiency by finding a back-door method of reducing the level of subsidy, it could introduce new ships and come to a leasing arrangement that was more prohibitive for the operator than was the case previously. It is that area of potential future dispute that gives me some cause for concern. However, it might be that the process is robust enough. That is the assurance that I am looking for.
In any negotiation, there are opportunities for opportunism, if you like, for the Executive and the operating company. If a larger ship starts to operate on a service, it will carry more passengers, which will bring in more revenue, but it might also cost more. It is not clear whether a new ship would need an increase or decrease in subsidy should it be introduced during the six-year contract. That would have to be negotiated.
On the flip-side, if I was operating a large vessel that I thought was not the right vessel to do the job, I might bring in additional vessels that were more suited to the route, although that might not be the vesco's view. Therefore, I could argue that the cost of leasing the vesco machinery should be less.
I am not sure whether provision has been made for such a scenario. As I understand it, once the tender process starts, the operating company is committed to leasing the existing ships. There are scenarios in which it might argue that it could do that more cheaply by using this or that vessel; however, it is not clear whether there is an obligation on the Executive or on the vesco to respond to such arguments.
Thank you. I will ask the minister about that when he is here.
That brings us to the end of our questioning. I thank Dr Paul Bennett for his participation in today's session.
I endorse what Paul Bennett said. His coverage of a complicated area that involves many different aspects of law, economics and politics was excellent and I endorse his submission to the committee. There are, nonetheless, a few points that I would like to add.
Thank you, Neil, for your paper and your presentation—I hope that it is okay to call you Neil.
Yes. When the issue of the retendering of the northern isles services came up, I wrote to the Scottish Executive and pointed out that at least the question of operator of last resort could be attended to. As I say in my paper, I did not really get a satisfactory response. Four years down the line, the question of operator of last resort has still not been attended to in that case, but it is absolutely critical to safeguarding the public interest. It will be an issue not only for the northern isles services but for the CalMac network.
Your evidence back in 2000-01 was to the effect that we could be making a costly public mistake as regards the tendering for the northern isles services. Your evidence—which I am sure you regretted having to give, being a taxpayer—has been borne out. So far, we have lost £13.4 million, and there are millions more to go. The evidence that you are now giving on CalMac should be—at the very least—examined more seriously than your previous evidence seemed to be.
I would emphasise one point. I did not anticipate the events that led to the retendering of the northern isles services. I doubt if anyone did. The point about providing for an operator of last resort is to provide for unexpected eventualities and to allow a recognised and qualified operator to step in immediately. That should be an operator that is on tap and available on a continuing basis.
I will come on to my final point, although I am sure that the committee has many other questions. I realised that this would require a bit of gazing into the crystal ball, but I asked Paul Bennett whether he could estimate the likelihood of legal action being taken by the Commission or by a private operator should the Executive pursue the transparent and open route of applying public service obligations to CalMac. In your opinion, is it necessary to go down the route of competitive tendering? Do you think that, as long as the public service obligation evaluation is open and transparent, that approach would be within the law?
I will make three points in response to that. First, it is a balance of risks. If the Executive goes down the route of competitive tendering as it is set out now, the risks are severe, in my view, as far as the public interest is concerned. Economics is about alternatives. The current alternative of competitive tendering carries genuine risks.
That was a very long—and very full—answer. As regards my point about possible legal action, for which I said that you would need your crystal ball—
To return to my third point, if CalMac were set up along the lines that I have suggested and leasing were ring fenced from operations, as is proposed in the current draft tender document, the PSOs and the associated level of compensation would be transparent. If we add on to that appropriate regulatory controls and auditing mechanisms so that the level of compensation that was provided to the CalMac network was demonstrably no more than could reasonably be expected from a comparable transport organisation under the Altmark ruling, I can see no basis on which CalMac could be accused of overcompensation or on which it could be argued that there was discrimination against other Community ship-owners.
Can I ask a question about—
A few other members want to come in.
I have a couple of quick points to put to Professor Kay on the back of Mr Sheridan's questions.
As far as I can see, there are no obvious potential operators within Scottish waters or Scottish jurisdiction. At the moment, the question does not arise because we have CalMac, which is a qualified ferry operator and which the Scottish Executive can instruct to undertake appropriate ferry operations. There are smaller operators, but it could be argued that they do not have the skills or the capability to run an entire network. That is exactly the point that I make in my paper. As I understand it, the Executive's current proposal to put the operator of last resort out to tender, which was mooted a few weeks ago, would create a further level of risk because if that were done under European Commission rules, the operator of last resort could end up being an operator that was outside UK jurisdiction. If a replacement operator were required overnight, that would make the ensuing negotiations on bringing that operator in extremely difficult. As far as I can see, such an arrangement would be extremely problematic.
I presume that it would have to be a two-stage arrangement, in that there would be an emergency back-up—a short-term tender—that might last for a year and another tender for a long-term operator.
As I mention in my paper, that question has come back from the Scottish Executive again and again. Indeed, its position has changed over the years. I have no satisfactory answer to the question, which is why I raised the issue. Given the proposed tendering arrangement, it is a severe problem.
I presume that that involves the Westminster Government and the European Commission.
I am sorry; will you clarify that last point?
I presume that qualification in the case of ferries would involve the Westminster Government, the European Commission and one of the international maritime awarding bodies.
No. That is where the problems arise. There is little, if any, reference to operators of last resort and regulatory authorities at European level. The Commission is concerned with the operation of the internal market to ensure that there is no discrimination or overcompensation. Matters such as regulation—which is the implementation of strategy—and the designation of the operator of last resort have fallen through a crack in the floorboards and are largely left to national bodies to deal with, not because the Commission regards them as unimportant, but because it considers that they are best left to national authorities to deal with.
At the moment, which body in the UK would be responsible for ferries? Would it be the Scottish Executive or the UK Government, through the secretary of state?
Do you mean who would be the operator of last resort?
Who would oversee regulation?
At the moment, the only regulator is the safety regulator, which is the Maritime and Coastguard Agency; there is no economic regulator as such. Part of the problem is that, south of the border, there is not the same level of subsidised public ferry services, if any. Ferry services in Scotland are more akin to UK rail services, for which there is regulatory provision, as there is for fuel and water services. However, there is no real precedent for an economic regulator for ferry services, largely because CalMac was constituted as a nationalised industry, so it was, in effect, self-regulatory and its own operator of last resort. The designation of the operator of last resort becomes an issue only when competitive tendering and private interests are introduced into the process.
You used the analogy of British Rail and the retention of BRB (Residuary) Ltd, under the Strategic Rail Authority, which took over the running of a franchise in England. Regardless of the approach that we take to the ferries—whether the regulatory approach that you propose or the tendering approach—would it be possible to construct a residual CalMac to act as operator of last resort instead of tendering for one?
One would assume that if that were possible, the Executive—after four years, at least—would have suggested the idea, but it has not, although I am not privy to the Executive's private discussions.
I will summarise what you said initially. You think that if we went down the route that you suggest, CalMac would have nothing to fear. I take it that you are talking about the light public service obligation route within a tendering framework. Will you clarify that?
Two basic issues relate to tendering. The first concerns state aids and overcompensation or discrimination. If the arguments that I make are pursued, it is possible to show that CalMac can be arranged as an operational entity without overcompensation or discrimination. The crucial issue comes down to one sentence in article 4 of the 1992 maritime cabotage regulation, which says:
Will you elaborate on that? At what point in the process would those safeguards be put in place?
The only option that the Executive has on the table is tendering. I have suggested a route by which CalMac could be reorganised, partly in response to points that have been made about the need to ring fence the leasing of vessels from CalMac's operations. It is critical to separate those matters. The Commission's communication of December 2003 expressly notes that as a device for making transparent the fact that the operation of ferry services is not subject to overcompensation.
When you talk about bringing the public interest into the process, do you mean public service obligation issues such as fare prices?
The current proposal for tendering CalMac services fails to consider how ferry policy and strategy are developed. Currently, CalMac, as the operator, has the additional responsibility of developing strategy, for example by proposing new vessels, the extension of routes and increases in the frequency of services. Even if CalMac's services are not put out to competitive tendering, CalMac's role will need to become simply that of an operational entity and deliverer of services. Consequently, strategy formulation and ferry policy, such as decisions on whether to build new vessels, will be left, almost by default, to the Scottish Executive. We have all focused on the implementation of public service obligations, but ferry policy on matters such as whether fares and service frequency should increase is an important social and economic issue. The fact that, whatever happens, CalMac's current role, which includes strategy formulation, will need to be reduced to operational status means that a whole area of public policy could be neglected by default or put into the hands of the Scottish Executive's transport division.
I have one further question.
I had intended to allow you only a short supplementary.
My question is related to that last point about issues such as fare levels under a public service obligation. Obviously, to a large extent, fares will depend on labour costs. Could a regulator take those types of issues into account to ensure that a fair assessment was being made?
The labour costs would not affect fares. As part of the PSO, maximum fare levels would be set for the operator, who would thus have no discretion to increase fares. Given the inability in the short term to deliver any increase in passenger volume on most routes to compensate for any reduction in fares, a monopoly operator would not normally consider reducing fares. De facto, fares would be frozen at their present levels, which are specified in the current CalMac timetable. That freezing of fares and of service levels comes with the PSO specification, so some further provision is required for revising the PSO.
In the section of your paper entitled "Final Thoughts", you say that the Executive has defined the problem too narrowly in saying that it is
The regulator would be an integral part—but only a part—of an alternative system. As a point of reference, I draw the committee's attention to how essential lifeline services are organised elsewhere. The proposal in my paper is uncontentious and straightforward; indeed, it is self-evident and obvious to those who deal with such matters. The problem is that, in Scotland, we have not encountered these regulatory authorities very often. That does not reflect anything lacking in or any incompetence by the Scottish authority; it is simply a lack of experience. The fact is that most experience of regulatory authorities, such as those that deal with gas, electricity, postal services, rail services and so on, has been at a UK level.
Just to play the devil's advocate, I point out that, although you say that there are regulators for other services such as rail, electricity, gas, water and so on, the operation of rail services has just been tendered and there is competition in the sector, albeit that subsidy is required to maintain services. That said, as I understand the situation, Network Rail is different. If we take rail as an example, how does having a regulator mean that tendering is not needed?
Let us say that the operation of the northern isles services is retendered and that, halfway through the period of the contract, the new operator says that it cannot meet the terms of the contract and is going to walk off into the sunset unless another £30 million of subsidy is paid. If the civil service in Edinburgh deals directly with the matter, it will be difficult for it to evaluate the matter independently, because it both awards and polices the contract. By removing the regulatory function and creating, if you like, a separate policeman that is independent of the civil service, there is more chance of creating transparency and objectivity that can be communicated to Brussels than there would be if those who award the contract also police it.
I understand the functions of the regulator and that an element of independence would be involved. However, I do not understand why having a regulator would mean that a country could avoid tendering. Rail is an example: there is tendering, albeit that public rail services are subsidised.
My proposal suggests that, along with tight auditing and investigatory controls by appropriate statutory bodies such as Audit Scotland and the Accounts Commission for Scotland, the regulator should be able to audit and monitor the operation of services in such a way as to communicate to the Commission that no more than the appropriate level of compensation, and therefore no overcompensation, has been paid in the conduct of services. The proposal is for what would probably be a six-year contract, subject to revision at the end of that time. Issues will arise in the course of the six-year period that will require renegotiation or discussion with the appropriate authorities. If the civil service in Edinburgh is doing that discussion and negotiation, the political process is brought into play and that is something about which Brussels would, at the very least, feel uncomfortable. However, having the cushion of a professional body—the regulator—that discusses issues with CalMac would insulate the political process from the operational process.
Okay. I turn to the last two steps in your proposal. The fourth step would be for
That might well be the case. However, a provision for independent auditing could be tacked on to the process.
Right. So, there would be an audit, but perhaps not right at the beginning.
The first point is whether an excess level of compensation could be expected. In the paper, I go through the extent to which CalMac as an operator could expect discretion to push at revenues or push down costs if the appropriate measures were taken to specify PSOs along the expected lines in the proposed tender document. The question is whether it would be possible to structure CalMac in such a way as it was expected to squeeze extra revenue or reduce costs beyond what we would expect from a normal operation. The argument that I put forward in my paper is that discretion would be almost squeezed out of the system, because so many of the costs would be outside the control of CalMac and there would be limited discretion—if any—to generate extra revenues. Certainly, price discretion would be squeezed out of the system.
I suppose that if there was a legal challenge by a company that said, "The Scottish Executive and Nicol Stephen broke the law by not putting the services out to tender," the company would have to quantify its claim by estimating the profits that it could have made if it had won the tender. You argue that if the service was regulated in such a way as to involve no profits, the challenger's claim would by definition have no value, even if it was well founded.
A company could not say, "The Executive broke the law by not putting the services out to tender," because tender itself is not embedded in the legal framework; it is a device whereby compliance with the legal framework can be demonstrated. The company would have to make its case in another way.
If, as you propose, a notice were to be placed in the OJEU to indicate that, instead of having a tender process, the Scottish Executive had decided that CalMac would continue to provide the service—in your model, a regulator would be appointed and the four other steps that you describe would be followed—and companies that wanted to challenge that decision would have to notify the Executive that they thought that they could do better, would such companies also have to lodge an interdict or initiate legal proceedings to prevent the Executive from taking a decision that the companies would argue was prejudicial?
The maritime cabotage regulation is opaque and open to interpretation on the matter. It says:
I wanted to touch on a few other areas, but I will come back to them at the end of the meeting, if there is time.
I would like to ask a couple of questions about your model, Professor Kay. You are absolutely right to say that we should be trying to explore every possible alternative to establish the best option for the ferry routes. My questions are about your proposals for regulation and the need to ensure that there is no overcompensation. You have identified some of the potential problems in your paper. Potential operators might believe that some routes could be profitable, and there is some debate around whether all CalMac's services would require subsidy. If they did not require subsidy, they would not require a PSO. If the regulator examined all the routes and identified three or four of them that were potentially profitable, would there be a danger that they might be cherry picked by another operator?
On those exact points, I refer members to the Europa institute meeting at which I presented a paper and at which the northern isles case was raised. The issue was mentioned by a senior European official, and the question why a light PSO was not used was raised. European Community law contains the communication of 22 December 2003, which sets the matter out in some detail.
Let us go back to the railway analogy. Back in 1996, the incumbent, ScotRail management, was outbid by the incomer, National Express Group. What if another operator out there believes that it could run the existing CalMac operation more efficiently than existing CalMac management?
I ask you to consider the breakdown of the costs, investment and leasing—all the elements on the PSO side of the process. The answer is that an operator has no real discretion. We tend to think of competition in terms of reductions in prices among competing firms, the introduction of new services and so on. That is not what the PSO process is about. Most of the process, with investment in new vessels and competition based on fares, would be excluded by the time that we put in place a PSO, which is about the delivery of a certain level of fares, frequency, timetabling and so on. Such discretionary aspects as manning levels and fuel costs are squeezed out of the system. The scope for innovation and competition is largely squeezed out of the system once the PSO is put in place.
Is it not the case that all those constraints were in place in relation to the railways, yet bids still came in that varied by many millions of pounds? Some railway franchises have been more successful than others in achieving market growth through better marketing, increased quality and so on.
A 10 per cent increase in rail fares would be a transport problem, as it would lead to a switch to cars and buses, and a 10 per cent reduction in rail fares would result in a switch from cars and buses to rail. As there are alternative modes of transport to the railway, we would describe such switches as transport problems. However, if ferry fares were increased, or reduced, by 10 per cent, there would be a regional development problem and a problem of maintaining regions, because there is not the same degree of flexibility and flux as exists between alternative modes of transport. Apart from partial and limited examples of air fares to some islands or peninsulas, there are not usually alternative modes of transport to the ferry. As the ferry is a monopoly provider of the transport service, there is not the same potential for increasing services, increasing demand or getting people to switch from alternative modes of transport that exists in the case of rail.
Could not an operator grow the market by increasing the tourism trade to the islands?
It could, but, as I say in my paper, someone does not go to Mull to use the Mull ferry service—they use the Mull ferry service to go to Mull. The appropriate level at which tourism, holidays and so on are developed is that of the tourism or development agencies. We would not expect transport operators to indulge in such work. The ferry journey is a means to an end, rather than being an end in itself. Even though I—along with many others—find ferry journeys enjoyable, they are a means to a final objective: they provide transport to the islands. It is at the level of the promotion and advertising of islands that advertising should take place. I do not see much scope for ferry operators to boost their revenues by advertising their services.
I will tease out the issues that Bristow Muldoon has raised. You are telling us that the process will effectively be to tender to manage and provide a service. Issues such as the route, the timetable, the type of ship, the maximum level of fares, the freezing of service levels, the level of manning and the cost of fuel are pretty much regulated and will be tightly defined.
I am not here to defend CalMac. Allegations have been made in the past of a high level of overheads and staffing costs at headquarters in Gourock. It is well worth my pointing out that, in part, that high level of overheads and staffing costs reflects the fact that CalMac still has responsibility for developing the structure. A good example is the new Bute ferry, which CalMac designed and built. Given that CalMac owns and manages its vessels and develops its markets, it has a level of commitment that we would not expect a lean, mean operator to incur.
You have just confirmed what I said. If the operator is no longer involved in building the ships—that work will be removed from mainstream activity, although it will still add to the cost base—and if it is no longer involved in route development because that area is fixed—again, that work will be stripped out, although it will still add to the cost base—an outside operator will need simply to look at the area aggressively and put in a lower tender. It will have a good idea of what everything else costs. If I could convince the banks that I could put up a credible case, I could go and do that job tomorrow.
Yes, but at the moment those activities have to be done. They will still have to be done—
But not by CalMac.
Exactly.
They will be done by the Executive. Unless CalMac is prepared to strip out those costs as well, they will still be part of its overall cost base when it submits a tender. That will not be the case for other operators.
If I was a banker who was looking at the costs, I would say, "Wait a minute. At the moment, CalMac has a higher level of costs as a result of having to take on these functions. Who is going to carry out those functions afterwards?" The potentially high level of overheads can and should be examined, but it reflects the particular case of CalMac, the history of which is that it was a nationalised company with many functions other than just operations.
That suggests to me that, despite the certainty that some people have about the big bundle of contracts in the tender, there is no guarantee that CalMac will continue, because if someone looks at the tender properly they will probably find a way to put in a lower bid.
If—
There are lots of ifs.
It is suggested that we strip out and ring fence various functions. First, there is the vessel owning and leasing function. Secondly, there is the regulatory function, which is somewhere in the ether because nobody seems to be picking it up—I presume that, by default, it falls to the transport division of the Executive. Thirdly, there is the strategy development function, which is concerned with planning new ships. Provided that homes are found for those essential functions, CalMac as an operational entity could be seen as the least-cost entity, along the lines that I suggest in my paper.
Something has to happen, whether it is based on your proposals or whether a tender process is undertaken. A mechanism has to be found to satisfy the Commission. From what I have heard, I am pretty sure that a tender process will not improve the level of service or the structure of the service and will not help to reduce costs for passengers. How would your proposal enable a reduction in fares or an improvement in the service?
If the option that I suggest is pursued, costs and revenues for each route will be visible, observable, measurable and transparent. On that basis, it will be possible to evaluate whether costs are too high or too low. There will be transparency and manageability in determining the appropriate level of subsidy for each route. There will still be an issue about the allocation of overheads—for example, some ships are shared between routes—so I am not suggesting that the approach will be entirely straightforward and simple, but it gets closer to the spirit of what is intended in the EC regulation.
In your paper, you make no mention of any hunger from local authorities—or from the regional transport partnerships that are coming through—to operate ferry services in the public interest on a not-for-profit basis or to convince their populations that they are able to deliver the additional or more user-friendly services for which many island and peninsular communities seem to be looking. Is there any reason for that?
There are two aspects to the matter. First, Argyll and Bute Council and Western Isles Council have not shown great enthusiasm for any of the services. A corollary of the gains to be had from the CalMac network is that hiving off individual routes is difficult to manage on a route-by-route basis—that is an essential point. It has been convincingly argued that if there are economies from shared vessels, staff, marketing and so on at the network level, hiving off individual routes on a council-run basis would be impractical or undesirable and would take councils into areas in which they do not have great experience.
Do you have a model? Perhaps you could drop the committee a note that gives us an idea about the point at which local communities and elected bodies could have an input in the process.
We must be careful. One thing that has come out of studies of regulatory authorities is the importance of regulators' independence from the political process. It would be easy for their role to be subverted. For example, the Commission would be wary of the role of a regulator who favoured a national firm over a firm from outside the national boundaries. People who have considered the process have strongly argued that it is important that regulatory authorities are independent of the political process. There is potential for bringing in councils and other interested parties in deciding what the PSOs should be, but implementation and maintaining and promoting appropriate levels of service should be left to regulators, as independent entities, to deal with.
In other words, local authorities and transport partnerships should have opportunities to express opinions when the original PSO is being set up, which, I presume, would be done with the involvement of the Scottish Executive in your model.
Exactly. However, they should have more than just an opportunity to express opinions. There should also be opportunities for seeing the ferries not only as a transport problem, but as an integral part of regional development. Opinions should be directly fed into the strategy-formulating process, of which councils should be an integral part. That would be prior to the PSO; once the PSO is in place, transparency and maintenance of fairness and objectivity on the part of the regulator will become all important.
How much time do we have to follow up your suggestions?
The question is: what are the alternatives? We can deal only with the alternatives that are available. If the alternative is competitive tendering as formulated, the arguments that I give against that still hold. My paper has an appendix on the northern isles services in which I make the point that the northern isles experience was—at the least—not one that the Executive wanted. However, we have a continuing service in the northern isles, and rushing in to retender would be worse than continuing with a clearly unsatisfactory process.
That brings us to the end of questions. I thank Neil Kay for his evidence.
Meeting closed at 16:32.