GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 1

Sustainable Mobility and Intermodality Promoting Competitive and Sustainable Growth

GALILEI

Galileo Organisational Scenario modelling

Written by: Company Date Signature

John Dewar, Anne MacPherson Milbank, Tweed, Hadley & McCloy 11/04/03

Kofi Henaku AST Legal Consultancy 30/01/03

David Wright Independent Contractor 30/01/03

James Brighton 30/01/03

Verified by:

John Dewar, Anne MacPherson Milbank, Tweed, Hadley & McCloy 20/06/03

Certified by:

WBS Code :I.2

Classification :PU

GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 2

THE INFORMATION IN THIS DOCUMENT IS PROVIDED AS IS AND NO GUARANTEE OR WARRANTY IS GIVEN THAT THE INFORMATION IS FIT FOR ANY PURPOSE. THE USER THEREOF USES THE INFORMATION AT ITS SOLE RISK AND LIABILITY. FURTHERMORE, DATA, CONCLUSIONS OR RECOMMENDATIONS IN THIS REPORT ARE PROVIDED ON THE BASIS THAT SUCH INFORMATION IS SUBSEQUENTLY, AND PRIOR TO USE, VERIFIED BY THE PARTY WISHING TO USE THAT INFORMATION.

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CHANGE RECORDS

ISSUE DATE § : CHANGE RECORD AUTHOR

1.0 21/02/03 First issue. N. deSilva

2.0 24/07/03 Second issue John Dewar, Anne MacPherson

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TABLE OF CONTENTS

1 EXECUTIVE SUMMARY ...... 13

1.1 INSTITUTIONAL STRUCTURES...... 14

1.1.1 Form of Public Authority...... 14

1.1.2 Regulatory functions and independent monitoring bodies...... 14

1.1.3 Ownership structure ...... 15

1.1.4 Ownership of Assets ...... 15

1.1.5 Security structures ...... 16

1.2 CONCESSION AGREEMENT ...... 16

1.2.1 Revenue Risk – availability payments and sharing of revenues ...... 16

1.2.2 Responsibility for system evolution ...... 17

1.2.3 Service Guarantee and performance measurement...... 17

1.2.4 Third party liabilities ...... 17

1.2.5 Risk management and sharing of risk ...... 17

1.2.6 Relationship between the GOC and the counterparty to the concession...... 18

1.2.7 Remedies in the case of the default of the GOC...... 18

1.2.8 Term - Duration of the concession and break mechanisms...... 18

1.2.9 Selection of PPP candidate...... 18

1.3 PROCUREMENT: SELECTION OF CONCESSIONAIRE...... 18

2 INTRODUCTION ...... 20

3 UK NATIONAL AIR TRAFFIC SERVICES (NATS) ...... 22

3.1 INTRODUCTION ...... 22

3.2 THE PPP PROCESS...... 22

3.2.1 Legal basis...... 23

3.3 THE PUBLIC AUTHORITY ...... 23

3.3.1 The Secretary of State for Transport ...... 23

LN1:#20065849 4 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 5 3.3.2 Authority ...... 24

3.3.3 HM Treasury...... 25

3.3.4 The Ministry of Defence...... 25

3.4 NATS ...... 26

3.4.1 Selection of a PPP Candidate ...... 26

3.4.2 Transfer of Assets under the transfer scheme ...... 26

3.4.3 The Organisation...... 27

3.4.3.1 National Air Traffic Services Ltd. (NATS)...... 27

3.4.3.2 NATS (En Route) Ltd. (NERL)...... 28

3.4.3.3 NATS Employee Sharetrust Limited (NESL)...... 28

3.4.3.4 NATS (Services) Ltd. (NSL) ...... 28

3.4.3.5 NATSNAV ...... 28

3.5 NATS LICENCE ...... 29

3.5.1 Services to be provided...... 30

3.5.2 Disposal of Assets ...... 30

3.5.3 Regulatory Accounting...... 30

3.5.4 Performance indicators and Standards of Service...... 31

3.5.5 Payment of Fees...... 31

3.5.6 Changes in shareholdings ...... 32

3.5.7 Charge Control ...... 32

3.6 LIABILITY...... 33

3.7 MONITORING AND ENFORCEMENT...... 33

3.7.1 Regulatory Instruments...... 34

3.8 CONCLUSION...... 34

4 NAV CANADA...... 36

4.1 INTRODUCTION ...... 36

4.2 THE PUBLIC AUTHORITY ...... 36

4.2.1 Ministerial Authority ...... 36

LN1:#20065849 5 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 6 4.2.2 The Canadian Transport Agency...... 37

4.3 THE CORPORATION...... 38

4.3.1 Governance...... 38

4.3.2 Ownership and charges ...... 39

4.3.2.1 Benefits of non-share capital/trust model ...... 40

4.3.3 Monitoring...... 41

4.3.3.1 Economic Regulation...... 41

4.3.3.1.1 Charges...... 41

4.3.3.2 Safety Regulation ...... 42

4.3.3.2.1 Level of Service, Changes to services and facilities ...... 43

5 THE DEFENCE FIXED TELECOMMUNICATIONS SYSTEM (DFTS)...... 44

5.1 BACKGROUND ...... 44

5.1.1 Approach in the selection of the private service provider ...... 44

5.2 INSTITUTIONAL STRUCTURES...... 47

5.2.1 Form of the Public Authority...... 47

5.2.2 The way regulatory functions are dealt with...... 47

5.2.3 Necessity of an independent monitoring body...... 48

5.2.4 Public sector requirements imposed on the private entity ...... 48

5.2.5 Ownership of assets ...... 49

5.2.6 Security structures ...... 50

5.3 AGREEMENT BETWEEN THE PUBLIC AND THE PRIVATE ENTITY ...... 51

5.3.1 Availability payments and sharing of revenues...... 51

5.3.2 Responsibility for system evolution ...... 52

5.3.3 Service guarantees ...... 53

5.3.4 Performance measurements...... 55

5.3.5 Third party liabilities ...... 55

5.3.6 Risk management and risk sharing ...... 56

5.3.6.1 How much risk to transfer ...... 57

LN1:#20065849 6 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 7 5.3.6.2 Risks from the scope of the contract ...... 57

5.3.6.3 Risks from long contracts ...... 57

5.3.6.4 Risk of pricing changes ...... 58

5.3.6.5 Risk to future competition...... 58

5.3.6.6 Risks associated with transfer payments...... 59

5.3.7 Relationship between the private entity and the counterparty to the concession ...... 60

5.3.7.1 Benchmarking...... 60

5.3.7.2 Value for money challenges...... 61

5.3.8 Remedies in the case of default by the private entity ...... 62

5.3.9 Duration of the concession and break mechanisms...... 63

5.4 LESSONS LEARNED ...... 64

5.4.1.1 Use of the EU negotiated procedure ...... 65

5.4.1.2 Bringing in external advisors at the planning stage...... 66

5.4.1.3 Scope of the contract...... 67

6 SKYNET 5...... 68

6.1 BACKGROUND ...... 68

6.1.1 Approach in the selection of the private service provider ...... 68

6.2 INSTITUTIONAL STRUCTURES...... 73

6.2.1 Form of the Public Authority...... 73

6.2.2 The way regulatory functions are dealt with...... 73

6.2.3 Necessity of an independent monitoring body...... 73

6.2.4 Public sector requirements imposed on the private entity ...... 74

6.2.5 Ownership of assets ...... 75

6.2.6 Security structures ...... 76

6.3 AGREEMENT BETWEEN THE PUBLIC AND THE PRIVATE ENTITY ...... 77

6.3.1 Availability payments and sharing of revenues...... 77

6.3.2 Responsibility for system evolution ...... 78

6.3.3 Service guarantees ...... 78

LN1:#20065849 7 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 8 6.3.4 Performance measurements...... 80

6.3.5 Third party liabilities ...... 80

6.3.6 Risk management and risk sharing ...... 80

6.3.6.1 Integration risk...... 81

6.3.6.2 Insuring risk of satellite loss...... 81

6.3.6.3 Contingency risks ...... 81

6.3.6.4 Market risk...... 81

6.3.6.5 Other risks...... 81

6.3.7 Relationship between the private entity and the counterparty to the concession ...... 82

6.3.8 Remedies in the case of default by the private entity ...... 82

6.3.9 Duration of the concession and break mechanisms...... 83

6.4 LESSONS LEARNED ...... 83

7 INMARSAT...... 85

7.1 BACKGROUND ...... 85

7.1.1 Approach in the selection of the private service provider ...... 86

7.1.1.1 Why Inmarsat had to restructure ...... 86

7.1.1.2 The Restructuring Agreements...... 90

7.2 INSTITUTIONAL STRUCTURES...... 92

7.2.1 Form of the Public Authority...... 92

7.2.1.1 Special Share ...... 93

7.2.1.2 Expanding the scope of IMSO...... 95

7.2.2 The way regulatory functions are dealt with...... 95

7.2.2.1 The Public Services Agreement...... 95

7.2.2.2 Companies Act ...... 96

7.2.2.3 FSA and the UK Listing Authority...... 97

7.2.2.4 British National Space Centre...... 97

7.2.2.5 DTI and the Radiocommunications Agency ...... 98

7.2.2.6 Ofcom ...... 99

LN1:#20065849 8 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 9 7.2.2.7 IMO 99

7.2.2.8 ICAO100

7.2.2.9 ITU 100

7.2.2.10 ...... 100

7.2.2.11 World Trade Organisation ...... 101

7.2.2.12 Federal Communications Commission...... 102

7.2.2.13 At the national level...... 103

7.2.3 Necessity of an independent monitoring body...... 103

7.2.4 Public sector requirements imposed on the private entity ...... 104

7.2.4.1 The Public Services Agreement...... 104

7.2.4.2 Supporting the public service obligations: practical examples ...... 106

7.2.5 Ownership of assets ...... 107

7.2.6 Security structures ...... 108

7.3 AGREEMENT BETWEEN THE PUBLIC AND THE PRIVATE ENTITY ...... 109

7.3.1 Availability payments and sharing of revenues...... 109

7.3.2 Responsibility for system evolution ...... 109

7.3.3 Service guarantees ...... 109

7.3.4 Performance measurements...... 109

7.3.4.1 Financial performance ...... 110

7.3.4.2 Operational performance...... 111

7.3.4.3 Performance of public service obligations...... 112

7.3.5 Third party liabilities ...... 113

7.3.6 Risk management and risk sharing ...... 114

7.3.7 Relationship between the private entity and the counterparty to the concession ...... 116

7.3.8 Remedies in the case of default by the private entity ...... 117

7.3.9 Duration of the concession and break mechanisms...... 119

7.4 LESSONS LEARNED ...... 119

8 ANALYSIS OF THE ‘TOLL-COLLECT’ ROAD TOLLING SCHEME IN GERMANY...... 121

LN1:#20065849 9 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 10 8.1 BACKGROUND ...... 121

8.2 INSTITUTIONAL STRUCTURE ...... 121

8.3 SELECTION PROCESS...... 122

8.4 ORGANISATIONAL MODEL...... 122

8.5 AGREEMENT BETWEEN PUBLIC AND PRIVATE ENTITY...... 124

8.6 SUMMARY IN LIGHT OF GALILEO...... 126

9 ANALYSIS OF ‘MESSINA STRAITS’ ITALIAN BRIDGE PROJECT ...... 128

9.1 BACKGROUND ...... 128

9.2 INSITUTIONAL STRUCTURES...... 130

9.3 SELECTION PROCESS...... 131

9.4 ORGANISATIONAL MODEL...... 132

10 LEGAL ANALYSIS OF PROCUREMENT RULES APPLICABLE TO THE SELECTION OF THE GALILEO CONCESSIONAIRE ...... 136

10.1 THE LEGAL FRAMEWORK FOR THE TENDER PROCESS...... 136

10.1.1 Introduction ...... 136

10.1.2 the proposed procurement process ...... 136

10.1.3 the legal framework of public procurement ...... 137

10.2 EU PROCUREMENT LEGISLATION ...... 138

10.2.1 EC Treaty...... 139

10.2.2 EU Procurement Directives...... 139

10.2.2.1 Application of procurement directives to Galileo ...... 140

10.2.2.1.1 Parties 140

10.2.2.1.2 Thresholds...... 141

10.2.2.1.3 General exclusions ...... 141

10.2.2.1.4 Exclusions from the Procurement Directives ...... 142

10.2.2.1.5 Possible exclusion of “satellite services”...... 142

10.2.2.2 Public Works Contracts ...... 143

10.2.2.3 Public Works Concession Contracts ...... 143

10.2.2.4 Subsidised Works Contracts...... 144

LN1:#20065849 10 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 11 10.2.2.5 Public Services Contracts ...... 144

10.2.2.6 Public Service Concession Contracts...... 145

10.2.2.7 Public Supply Contracts ...... 146

10.2.2.8 Utilities Contracts...... 146

10.2.3 Award Procedures ...... 147

10.2.3.1.1 Open Procedures ...... 148

10.2.3.1.2 Restricted Procedures...... 148

10.2.3.1.3 Negotiated Procedures...... 148

10.2.3.1.4 Notices 150

10.2.3.1.5 Information Concerning The Contracting Authority’s Decision ...... 150

10.2.3.1.6 Content and Presentation of Notices...... 151

10.2.3.1.7 Pre-selection of bidders ...... 151

10.2.3.1.8 Rules governing the dispatch and content of invitations to tender...... 153

10.2.3.1.9 Award criteria ...... 153

10.2.3.1.10 Typical breaches of procurement rules ...... 153

10.2.4 Remedies for breach...... 154

10.2.5 Future Developments in EU Procurement Law...... 155

10.3 WTO PROCUREMENT RULES...... 156

11 RECOMMENDATIONS AND CONCLUSIONS ...... 159

11.1.1 General ...... 159

11.1.2 Questions to ask ...... 160

11.1.3 External expertise ...... 160

11.1.4 Tender document ...... 160

11.1.5 Initial competition ...... 161

11.1.6 Avoiding memory loss...... 161

11.1.7 Security ...... 162

11.1.8 Levels of demand for services...... 162

11.1.9 Continuing competition...... 162

LN1:#20065849 11 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 12 11.1.10 The relationship ...... 163

11.1.11 Benchmarking & monitoring performance...... 164

11.1.12 Risk allocation...... 164

11.1.13 Risk management ...... 165

11.1.14 Operational risks...... 168

11.1.15 Contract changes...... 168

11.1.16 Financial transparency and risk management...... 169

11.1.17 Value for money challenges...... 169

11.1.18 The official face ...... 170

11.1.19 Service guarantees ...... 170

11.1.20 A Public Service Agreement ...... 170

11.1.21 Legislation/Institutional Structures...... 171

11.1.22 Third party liability ...... 171

11.1.23 Managing the concession ...... 171

11.1.24 Accountability...... 172

11.1.25 Term Out provisions and Recompetition for concession...... 172

11.1.26 Remedies ...... 173

11.1.27 Independent monitoring ...... 174

11.2 PROCUREMENT...... 175

11.2.1 Applicable Procurement Rules...... 175

11.2.2 The Tendering Process ...... 176

11.2.3 Global Participation ...... 176

11.2.4 The Benefits of Public Sector Financial Support during the Preparation of Bids ...... 177

12 DEFINITIONS AND ACRONYMS ...... 178

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1 EXECUTIVE SUMMARY

The aim of this report is to enable the definition of a suitable and viable organisational scenario for Galileo, focusing on the public and commercial aspects of the system. This is achieved by (i) comparing the institutional structures and form of concession agreement used or contemplated in the seven PPP case-studies set out below and (ii) analysing the EU and WTO procurement regimes applicable to the selection of the concessionaire.

This report contains PPP case-studies relating to the following projects, each of which have features of relevance to Galileo:

• Defence Fixed Telecommunications System (DFTS)

• Skynet 5

• Inmarsat

• UK National Air Traffic Services (NATS)

• NAV Canada

• “Toll-Collect” Road Tolling Scheme in Germany

• “Messina Straits” Italian Bridge Project

The Galileo PPP model assumed for the purposes of this report is illustrated in the diagram below. Governments / International Relations JOINT UNDERTAKING / GALILEO PUBLIC AUTHORITY

Funding (EC / ESA) Support INDUSTRY / Concession SERVICES Agreement Public € EQUITY

E.I.B. COMMERCIAL Debt € Equity € NON- BANKS Galileo PPP Company CONTRACTOR 'CONCESSIONAIRE' EQUITY (E.g. public offering) “GALILEO BONDS” Subsidiaries

SYSTEM PRIME COMMERCIAL INFRASTRUCTURE NETWORK CONTRACTOR OPERATIONS PROCUREMENT CONTROL

SUBCONTRACTORS MAINTENANCE / SERVICE REPLENISHMENT SUBCONTRACTOR PROVIDERS / CONTRACTS USERS / SHADOW FEE

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1.1 INSTITUTIONAL STRUCTURES

1.1.1 FORM OF PUBLIC AUTHORITY

In each of the case-studies examined (other than Inmarsat1), the public authority is a governmental entity or quasi governmental authority2. This will also be the case for Galileo, where the indication is that that the public authority will be a combination of the JU, the EC and/or ESA. This is the first time that this combination of institutions has been involved in procuring a satellite system provider. Thus it is vital for these institutions to learn from the experiences of the public authorities in the case-studies described in this report.

In particular, given the breadth of the institutions comprising the Galileo public authority, the JU/EC/ESA should consider creating the equivalent of an Integrated Project Team (IPT) (as used in DFTS project and Skynet 5). As in these case studies, the Galileo IPT would contain a multi-disciplinary set of expertises, including those involved in negotiating and administering the Galileo concession. Its task would include monitoring on a regular basis, the performance of the concession and taking action necessary to resolve any disputes, disagreements or problems arising in connection with the concession.

1.1.2 REGULATORY FUNCTIONS AND INDEPENDENT MONITORING BODIES

The nature of the regulatory function for a PPP is based on the type of services being provided by the PPP company. For NATS and Nav Canada, regulatory functions are performed by the aviation regulators in the UK and Canada respectively, for DFTS these functions are performed by the UK telecommunications regulatory authority, for Skynet 5 these functions are performed by the Department of Trade and Industry, the UK representative to the ITU and for Inmarsat these functions are performed by a range of institutions including the British National Space Centre and the UK Radiocommunications Agency.

The case-studies demonstrate that these regulatory functions effectively ensure that the standards for the services being provided are being set and achieved. Regulatory functions will need to be facilitated by a similar authority for Galileo to ensure that the Galileo services are being satisfactorily provided. Given the pan-European nature of Galileo, it may be necessary to utilise/implement separate international/European regulatory bodies in addition to the existing national regulators.

In addition, the case-studies3 demonstrate that it is necessary for these standards and the pricing of services to be regulated and enforced by an independent monitoring body. Such a body should be set up for Galileo and its role would include checking and benchmarking the price of services4 and investigating safety matters5. However, any regulation of pricing needs to be considered carefully. During the forthcoming bidding process the applicable rules must

1 Following the restructuring of Inmarsat, an intergovernmental body (IMSO) was set up which includes a public authority-type function. 2 The public authority is the Department of Defence for DFTS and Skynet 5, the CAA and Department of Transport for NATS, the Ministry of Transport and Canadian Transportation Agency for Nav Canada, regional governments and Italian state-owed industries for Messina Straits and the Federal Ministry for Transport, Building and Housing for Toll-Collect. 3 It is noted that such a body was not considered to be necessary for Skynet 5, where the Ministry of Defence undertakes an “intelligent customer” function in conjunction with other bodies, but such a body is considered necessary for Galileo, as is the case in relation to the other case-studies. 4 Supervision is performed by the NAO for the DFTS contract. 5 Supervision is provided by the Minister of Transport with respect to Nav Canada.

LN1:#20065849 14 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 15 be made known in order for bidders and their lenders to make a sound economic assessment of Galileo’s revenue streams and their ability to meet operating costs, service debt and provide a return on equity commensurate with the risks of undertaking the project. If price regulation is to be introduced it may well only be appropriate in the context of certain services and some would argue that pricing will be subject to market pressures to some degree since users could choose to use other providers (such as GPS for example).

Finally, in order effectively to implement any system of regulation, as is the case with NATS, the Galileo concession agreement should require the PPP company to provide the necessary information to the regulator/independent monitoring body to ensure that its services and its compliance with the concession agreement may be correctly assessed.

1.1.3 OWNERSHIP STRUCTURE

The case-studies examined provide a range of examples of different ownership structures. Traditional PFI-type ownership structures are assumed in DFTS, Skynet 5 and Toll-Collect where the PPP companies are made up of consortia of companies from private industry. In contrast, there is public participation in the PPP company for NATS, where the government has a shareholding including a “golden share”, Inmarsat, where IMSO holds a special share in the holding company and Messina Straits, where it is proposed that the PPP company be a joint venture between the private sector and the specially formed public sector company. Nav Canada, however, is structured as a non-share capital corporation which is a private not for profit organisation without governmental participation.

Unless public sector involvement in Galileo is required for political or other reasons, it appears that the traditional PPP ownership structure (i.e. where the private sector alone owns the PPP company) will be more appropriate for Galileo. This structure ensures a clear separation between the public and private sectors and accommodates the transfer of risk between public and private sector which is fundamental to a PPP structure. Although the non-share capital corporation structure adopted for Nav Canada may be seen as an attractive compromise, the absence of private sector equity ownership in this entity could result in there being a lack of incentive for the PPP company to maximise its performance since it will not make any profits from doing so.

In addition, the two-tier structure of a holding company and a management company which is used in NATS, may also be a means of further enhancing the efficiency of the Galileo PPP company’s operations. The public authority will also have a degree of control over Galileo’s operations under the concession agreement, although if the Concessionaire is expected to manage the operating risks of the project, it should also be given the tools to do so with minimal interference from the public sector, until such time as it is failing to provide the prescribed services of is otherwise in material breach of the concession agreement.

1.1.4 OWNERSHIP OF ASSETS

In the case-studies examined, the PPP company owns the system assets and they are transferred back to the public authority at the conclusion of the concession period. However it is currently being suggested that rather than this arrangement, the public sector could own all or part of the Galileo assets. This public ownership of assets is not compatible with the risk transfer fundamental to a PPP structure (i.e. whereby ownership and management is transferred to the private sector and in return the public sector receives better quality and value for money services) and could also be disadvantageous to the private sector’s ability to attract finance. Therefore, it appears that if Galileo is to use a PPP structure, private sector ownership of the PPP company which is transferred back to the public sector at the conclusion of the concession period, will be most appropriate for Galileo.

LN1:#20065849 15 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 16 Public sector control over Galileo asset ownership could instead be addressed by using a mechanism under the concession agreement similar to the one used in NATS whereby the PPP company may not dispose of any interest which it holds or relinquish operational control which it has over any asset without providing three months’ written notice of its intention to do so to the public authority.

1.1.5 SECURITY STRUCTURES

Galileo may provide services with elements of national/international security and the cases of DFTS and Skynet are of particular relevance in this respect. Here the UK government operates a scheme whereby the personnel, procedures and buildings of private companies can be qualified to hold Government information and materials securely. In addition all non- MOD customers offered use of the DFTS system must satisfy security criteria. Although limited information is available in relation to the security arrangements for Skynet 5, it appears that similar controls are in place. These examples will be of relevance to Galileo in relation to its security arrangements.

1.2 CONCESSION AGREEMENT

1.2.1 REVENUE RISK – AVAILABILITY PAYMENTS AND SHARING OF REVENUES

DFTS and Skynet 5 use a typical PPP payment structure whereby two types of payments are made to the PPP company under the concession agreement – a fixed availability payment and a payment based on usage of the system/achievement of system milestones. Toll- Collect uses a structure whereby there is a public contribution of some 20% of the total financing costs and if revenue does not cover operational costs, the public sector pays a top- up amount.

Nav Canada uses a different payment arrangement whereby the PPP company may secure government grants or taxes/user charges which are limited to the level of costs incurred, since Nav Canada is a non-profit organisation. Messina Straits has not yet finalised its payment arrangements but a greater public sector contribution6 is proposed which is in line with its greater public participation but unusual for a PPP. By contrast, in NATS, the PPP company pays fees to the public authority.

Unlike Toll-Collect which does not assume any revenue risk, Galileo is likely to assume significant revenue risk, although the PWC Report indicates that the revenues accrued could be substantial and it is proposed that Galileo have discretion on level of charges and revenue collection.

Thus availability payments depend on the ownership structure and revenue arrangements for a project and if Galileo proceeds on a traditional PPP basis of private sector ownership of the PPP company, it is recommended that the fixed and usage-based availability payment arrangements are considered for Galileo and that the precise level of these payments be set based on either assumed or actual revenues from other sources. If the public sector payments fluctuate based on assumed revenue streams bid by the private sector, then due to the risks involved, the concessionaire will expect higher returns on equity. If public sector payments vary based on actual revenues accruing to the concessionaire, then the private

6 This is currently proposed to be in the region of 50% of infrastructure costs together with an annual public contribution to operation and maintenance, There is also the possibility of shadow tolls which PWC recommended be at a flexible level.

LN1:#20065849 16 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 17 sector will expect lower returns on its capital reflecting the lower risks involved. Since it is important that the concessionaire is incentivised to maximise privately generated revenues, consideration should be given to sharing the revenue risk so as to lower the cost of private capital and to incentivise the concessionaire to maximise the revenue streams available to it.

1.2.2 RESPONSIBILITY FOR SYSTEM EVOLUTION

DFTS provides an interesting example of the allocation of responsibility for system evolution. Here, responsibility for system evolution is viewed as a joint responsibility of both the public authority and PPP company. If the public authority identifies a new service requirement, it can request a proposal from the PPP company for its delivery and if the public authority is not satisfied with the proposal, it can seek the service from another supplier.

It is recommended that Galileo take a similar approach whereby the Galileo concession contract includes a requirement that the PPP company accommodates increasing standards over time to ensure that the Galileo services do not fall behind advances in technology which future markets and technical breakthroughs may provide. In addition, it is recommended that Galileo use a similar arrangement as DFTS and set up a business planning group comprised of the public authority, PPP company and user groups, which meets regularly and considers whether new and improved services are desirable.

1.2.3 SERVICE GUARANTEE AND PERFORMANCE MEASUREMENT

The question of service guarantees is an important one for Galileo and differing approaches are taken in each of the case-studies.

For example, in DFTS, the concession agreement contains detailed specifications for each service and where a service does not meet the requirements, there are contractual provisions for payments to be reduced or terminated. In Skynet 5, the PPP company has similar contractual obligations.

The NATS UK PPP company is obliged to provide a statement in respect of service performance and standard indicators. The statement must set out measures (including, without limitation, delays, service interruptions and complaints) against which its performance and quality of service may reasonably be assessed. Although NATS UK does not make any specific service guarantees, it is obliged to provide a service and investment plan as part of its 5 yearly business plan. This plan, together with the statement of performance indicators, ensures that the CAA can monitor safety indicators and performance of the company.

1.2.4 THIRD PARTY LIABILITIES

The case studies show a number of ways of managing third party liability. Inmarsat provides a typical example where third party liability is addressed through a combination of insurance policies, operational practice and sharing with service providers.

1.2.5 RISK MANAGEMENT AND SHARING OF RISK

The case studies demonstrate the importance of detailed risk management. The underlying contracts will determine the allocation of risk between the parties. It is essential that the parties identify all of the risks associated with a project and then allocate these risks to the party best able to manage them. Although much of the risk associated with Galileo may be expected to be carried out by the GOC, not all risk can be transferred and the EC/ESA/JU and GSB should be satisfied with GOC’s risk management and risk strategy as part of the concession contract.

LN1:#20065849 17 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 18 1.2.6 RELATIONSHIP BETWEEN THE GOC AND THE COUNTERPARTY TO THE CONCESSION Joint organisational structures are needed to manage and prioritise the evolution of the Galileo system. In DFTS, the joint MoD/BT Business Planning Group in DFTS appears to be a useful model for implementation of the Galileo concession. In the Galileo context, such a business planning group could comprise representatives from the ESA, the EC, Member States and/or certain user groups. The EC and the ESA may also wish to consider not only regular meetings with the concessionaire but actually being present on site, as was the case for Inmarsat.

1.2.7 REMEDIES IN THE CASE OF THE DEFAULT OF THE GOC

The EC/JU will need to build-in remedies in the event of a failure by the GOC to comply with the terms of its concessions contract. Like those in the DFTS contract, the remedies will need to vary in proportion to the seriousness of the failure to comply. For example, in Skynet 5, remedies range from service credits in the case of performance shortfalls to contract termination for failure to deliver for, for example, gross breach of security.

1.2.8 TERM - DURATION OF THE CONCESSION AND BREAK MECHANISMS

The EC/JU should consider carefully the appropriate duration of the concession in light of the costs and benefits associated with the proposed term. The EC and ESA should also ensure that the concession contract includes provisions for renewed competition at the end of the term and that any transfer payments which a new concessionaire makes to the existing concessionaire are not so high to undermine the prospect of renewed competition.

The case studies give examples of different concession terms: for example, the NATS UK concession is for a minimum of 20 years plus 10 years if requested by the Secretary of State, Toll-Collect provides for a 12 year contract period and, whilst the Messina Straits concession is not yet determined, it is likely to be in the region of 25-25 years.

1.2.9 SELECTION OF PPP CANDIDATE

All schemes had shortlisting following initial expression of interest from a number of entities.

1.3 PROCUREMENT: SELECTION OF CONCESSIONAIRE

An effective public procurement policy is fundamental to the success of Galileo. The procurement strategy for Galileo will need to be tailored to the specific needs of the public sector and the unusual nature of the project itself.

In order for the private sector to provide the necessary capital for Galileo on a cost effective basis, it will be necessary for a long-term concession to be awarded to the concessionaire. It is obviously desirable from the outset that the concession be awarded to a competent and financially viable concessionaire which will provide the required services for the duration of the concession.

As can be seen from Section 10, the procurement rules are complex, but essentially there are three different approaches reflected in the “open”, “restricted” or “negotiated” procedures. This report examines these options and concludes that, at this stage, a negotiated procedure appears to be the most appropriate procurement route.

LN1:#20065849 18 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 19 Any such procedure would need to be combined with a call for competition. Bearing in mind the highly specialised services to be provided by the Galileo concessionaire and the relatively limited pool of private sector entities which have the necessary technical and industrial capabilities to carry out the services, a wide spectrum of interested parties should be kept involved in the process. Moreover, it the public sector is to achieve its economic and strategic goals, it will be important for the process to facilitate bids from interested parties both within and outside the EU.

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2 INTRODUCTION

This report has been prepared to enable the definition of a suitable and viable organisational scenario for Galileo, focusing on the public and commercial aspects of the system. This is achieved by (i) examining a selection of case studies in Sections 3 to 9 of this report and (ii) analysing the EU and WTO procurement regimes applicable to the selection of the Galileo concessionaire in Section 10 of this report.

Section 3 analyses the case of the UK National Air Traffic Services (NATS). NATS provides air traffic services over UK airspace and the eastern part of the North Atlantic. NATS was established in 1962 and restructured as a public private partnership in 2001 following the privatisation of the Civil Aviation Authority. It is now regulated by the public sector pursuant to both legislation and the terms of its license. As a PPP within the European aviation sector, NATS provides a useful insight of privatisation and liability issues in a sector of great relevance to Galileo.

Section 4 looks at NAV Canada, which is responsible for civil air navigation over Canadian airspace. Following the commercialisation of air navigation services in Canada, NAV Canada was incorporated in 1996 as a non-share capital corporation with financial independence. Its role is (subject to certain exceptions) to provide civil air navigation services under the authority of the Canadian Ministry of Defence. Although perhaps not as directly relevant to Galileo as NATS, NAV Canada provides an alternative analysis of a “quasi PPP” which is of interest in the context of Galileo.

Section 5 examines the Defence Fixed Telecommunications System (DFTS) in the UK. DFTS provides a telecommunications network to the UK Ministry of Defence and was implemented as a privately financed system under the UK private finance initiative in 1997. It is subject to the scrutiny of both the UK Ministry of Defence and National Audit Office. Of the PPPs examined in this report, DFTS has been operating the longest and thus provides invaluable lessons which are of relevance to Galileo.

Section 6 looks at the case of Skynet 5 in the UK. Skynet 5 will provide the next generation of satellite communications services for the UK military. Skynet 5 has not yet been implemented but the preferred bidder was announced in 2002 and, subject to successful negotiation, a private finance initiative is expected to be put in place imminently. Like DFTS, Skynet 5 will be placed and administered by the UK Ministry of Defence. Skynet 5 has certain structural similarities to DFTS and thus demonstrates the evolution of this genre of PPP in the current market.

Section 7 analyses Inmarsat. Inmarsat originated from the International Maritime Organisation and was privatised and restructured as two different bodies (being a commercial entity and a public service entity) in 1999. Inmarsat owns and operates a global satellite network and provides services through a worldwide group of service providers offering mobile telecommunications in the air, on land and at sea to a number of registered users. The experience of Inmarsat raises interesting issues which are useful in relation to the international aspect of Galileo and the transformation of an intergovernmental organisation to address the current market.

Section 8 is an analysis of the ‘Toll Collect’ Scheme in Germany. This scheme is a heavy goods vehicle toll collect system which uses GNSS technology for its operation. Although the structure used is different from that proposed for Galileo, the programme does encounter some of the same issues which Galileo will need to consider at the concessionaire/joint venture stage. The institutional relationship, revenue sharing, and liability issues are also potentially of great relevance to Galileo.

LN1:#20065849 20 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 21 Section 9 is an analysis of the ‘Messina Straits’ Italian Bridge project. This project relates to the proposed bridge that is to be built between mainland Italy and Sicily. Although the idea of an infrastructure project has been around for hundreds of years as a traditional PPP, the political considerations and ownership issues are substantial. Thus, although a different type of programme to Galileo, it does touch on variables that will be key in order to optimise the PPP structure for Galileo.

Section 10 examines the EU and WTO procurement regimes applying to the selection of the Galileo concessionaire. This section examines the relevant EC Treaty provisions, the EU procurement directives, the EU Remedies Directives and the WTO Government Procurement Agreement. These regimes must be complied with and their objective is to establish a policy of openness in the procurement of Galileo and associated cost savings for public authorities.

Section 11 sets out consolidated recommendations and conclusions in relation to each of the case-studies and procurement regimes outlined above.

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3 UK NATIONAL AIR TRAFFIC SERVICES (NATS)

3.1 INTRODUCTION

The UK National Air Traffic Services (NATS) is the organisation that provides air traffic services in UK airspace. It also provides services over the eastern part of the North Atlantic. The UK Civil Aviation Authority (hereafter, CAA) was responsible for civil aviation safety, the economic regulation of air operators and the provision of air navigation services at the major .

With the privatisation of the hitherto wholly owned CAA subsidiary – NATS – the responsibility for the provision of air traffic services is no longer a public one. The privatised NATS is regulated by the public sector under statutes and the terms of its licence.

3.2 THE PPP PROCESS

NATS was established in 1962 as a unified civil-military organisation to run UK’s air traffic control. In 1986 it was absorbed into the Civil Aviation Authority.

In 1993 the UK Government proposed options for the privatisation of NATS. NATS was restructured in 1996 as a company under the Companies Act to be wholly owned by the CAA in preparation for privatisation. NATS had full management control of its own finances and responsibilities for its own operations.

In 1998 the Government proposed that NATS should become a Public-Private Partnership (PPP). The Government believed that the option would have a number of benefits, including that it would free NATS from public sector spending constraints and thereby safeguard its investment programme, better meet its customer needs, separate service provision from regulation, broaden the management base, and foster the development of a global management base.

A number of options were addressed for the privatisation, including:

(a) privatisation as a regulated utility or a private contractor;

(b) a non-shareholding non-profit making company/trust;

(c) a public corporation;

(d) a chattered independent public-owned company; or

(e) an improved PPP.

The Parliamentary Select Committee on Transport (Transport Committee) critically examined these reasons and options on several occasions. The Committee had reservations about the privatisation of NATS as a profit making company, particularly considering the defence implications of its activities.7

7 See for instance Fourth Report of the Environment, Transport and Regional Affairs Committee, Air Traffic Control, HC (1977-98) 360-I, para. 77.

LN1:#20065849 22 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 23 While the profit – making argument was not given any serious credence by Parliament, the dual role of the CAA as the ATC operator and safety regulator was not considered acceptable to the Transport Committee.

Indeed, in its third Report on the NATS PPP, the Committee reiterated the view that in order to prevent any possible conflict of interest between safety regulation and operational responsibility, the CAA’s Safety Regulatory Group should be quite separate from NATS. In its view, “whatever else is decided about the future status of NATS, to effect proper safety regulation of the company the status quo cannot continue”.8

The Parliamentary Select Committee, in its third report, was not convinced of the need for a PPP for NATS. In its view it will lead to operational control of NATS being ceded to a private investor which is very likely to raise costs, jeopardising safety, or to increase revenues, by raising charges to its customers. Although the Committee did not share the enthusiasm of the CAA and the Department of Transport for a profitable NATS as a PPP with a 49% government shareholding, in the view of the Committee government should only sell the planned 46% to a bidder committed to making no commercial return on NATS operations. The Committee thus strongly favoured the trust model as represented by NavCanada.

In response to views expressed through a consultation process and by the Parliamentary Select Committee, changes were made to Government proposals for a NATS, mainly in the field of safety regulation, enhancing the economic regulatory structures and maintaining a strict separation between CAA and NATS.

3.2.1 LEGAL BASIS

NATS was established, operates and is regulated under a set of legislation adopted for that purpose. The most significant statutes and statutory instruments are the Transport Act 2000 and the Air Navigation Order 2000. The company was licensed to provide air traffic services within the UK airspace by the Air Traffic Services License for NATS (En-Route) Limited.

These legal instruments will be examined in the rest of this section.

3.3 THE PUBLIC AUTHORITY

The Public Authority is constituted by the Department of Transport and the Civil Aviation Authority. Two major departments of the CAA oversee various aspects of the operations of the PPP company. These are the Safety Regulatory Group, the Economic regulatory Group. The Department of Defence also exercises some control.

3.3.1 THE SECRETARY OF STATE FOR TRANSPORT

The Secretary of State is charged with the duty of maintaining a high standard of safety in the provision of air traffic services. In pursuance of this objective the Secretary of State for Transport may:

• grant a licence in respect of air traffic services9;

8 Third Report of the of the Environment, Transport and Regional Affairs Committee, The Proposed Public- Private Partnership for National Air Traffic services Limited, NC-35 9 S. 6, Transport Act 2000.

LN1:#20065849 23 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 24 • be notified of a winding up of a licence company10, apply for an air transport administrative order11;

• make grants or loans to a licensed company and guarantee loans made to a licence company being the subject of an administrative order12;

• issue directions to the licence company in the interest of national security13 and the environment14;

• direct the CAA to make a transfer scheme15; or make a transfer scheme, failing a CAA transfer scheme16’;

• oversee the transfer of 51%17, retention of 49% 18 of Crown shareholding, and ensure that that the Crown holds a Golden share (special share or veto right)19;

• with the Treasury’s approval, make loans20 or grants21 to, guarantee22 the discharge of financial obligation of the transferee company - this company must be a company wholly owned by the Crown, wholly owned by the CAA or is a subsidiary of such a company; and

• extinguish the liabilities of a transferee which is a wholly-owned CAA company23.

3.3.2 CIVIL AVIATION AUTHORITY

The CAA is the UK's aviation regulator. Its specific responsibilities as prescribed in the Civil Aviation Act, 1982, include air safety, economic regulation, airspace regulation and consumer protection.

In particular, the CAA ensures that UK civil aviation standards are set and achieved. This duty is assigned to the CAA’s Safety Regulation Group (hereafter, SRG). In addition it regulates airlines, airports and NATS’ economic activities and encourages a diverse and competitive industry. The Economic Regulation Group (hereafter, ERG) is charged with undertaking this responsibility. Furthermore, it brings civil and military interests together to ensure that the airspace needs of all users are met as equitably as possible. The responsible agency is the Directorate of Airspace Policy (hereafter, DAP).

The Transport Act 2000 sets out specific duties of the CAA in relation to the PPP process and the regulation of the PPP company. Under the Transport Act 2000, against the global objective of maintaining a high standard of safety in the provision of air traffic services, the CAA may or shall:

10 S. 26 (4), Transport Act. 11 S. 28. 12 S. 31. 13 S. 38. 14 S. 39. 15 S. 43. 16 S. 45. 17 S. 51 (3). 18 S. 51 (4). 19 S. 51 (6). 20 S. 52. 21 S. 54. 22 S. 53. 23 S. 57.

LN1:#20065849 24 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 25 • with the consent of the Secretary of State, grant24 or modify25 a licence to provide air traffic services;

• refer anti competitive practices to the Competition Commission26;

• issue orders securing compliance with conditions of a licence27;

• participate in the judicial process leading to the winding up of a licence company, including issuing administrative orders28;

• make a transfer scheme29 – to be approved by the Secretary of State;

• where directed by the Secretary of State, extinguish liabilities owed by a licence company30;

• perform air navigation functions assigned to it under Chapter III of the Transport Act 200031; and

• specify, regulate and enforce charges for air traffic services32.

3.3.3 HM TREASURY

Previous to the privatisation of NATS, the organisation was a wholly owned subsidiary of CAA for which reason its finances were provided for and controlled by the Treasury. The Treasury does not allow publicly owned companies to borrow money commercially.

Following the privatisation, the involvement of the Treasury, is limited to the occasions the Secretary of State may be called on to make grants, loans, or guarantee loans to a bankrupt licence company.

3.3.4 THE MINISTRY OF DEFENCE

Unlike the Treasury, the involvement of the Ministry of Defence in the regulation of the provision of air navigation services is still retained under the Transport Act. Section 72 of the

24 S. 6. 25 S. 11. 26 S. 12. 27 S. 20. 28 SS. 26 et. seq.. 29 S. 43. 30 S. 57. 31 S. 66 et. seq. The functions are specified under Section 76 as follows: (a) to secure the most efficient use of airspace consistent with the safe operation of aircraft and the expeditious flow of air traffic; (b) to satisfy the requirements of operators and owners of all classes of aircraft; (c) to take account of the interests of any person (other than an operator or owner of an aircraft) in relation to the use of any particular airspace or the use of airspace generally; (d) to take account of any guidance on environmental objectives given to the CAA by the Secretary of State after the coming into force of this section; (e) to facilitate the integrated operation of air traffic services provided by or on behalf of the armed forces of the Crown and other air traffic services; (f) to take account of the interests of national security; (g) to take account of any international obligations of the notified to the CAA by the Secretary of State (whatever the time or purpose of the notification). 32 S. 73 et. seq.

LN1:#20065849 25 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 26 Civil Aviation Act, 1982 calls for Directions to the CAA in the maintenance of joint and integrated provision of civil and military air navigation services. Section 66 of Transport Act 2000 retains this structure of civil-military cooperation.

The Civil Aviation Authority (Air Navigation) Directions 2001 is promulgated to re-empower the CAA’s Directorate of Airspace Policy to ensure civil-military coordination.

3.4 NATS

3.4.1 SELECTION OF A PPP CANDIDATE

It may be recalled that the Government has argued that a strategic investor was needed to take on 46% of the shares then held by the Crown. Following and expression of interest by a number of consortia, the UK Government, on 3 November 2000 announced the short listing of three consortia, being:

• NIMBUS whose equity participants are SERCO and PPM Ventures, with technical assistance being provided by ARINC and Cranfield University.

• NOVARES whose equity participants are Lockheed Martin, Apax Partners and Airways International Ltd, with technical assistance being provided by AEA Technology and DERA.

• THE AIRLINE GROUP Ltd. whose equity participants are British Airways, British Midland, Virgin Atlantic, Airtours, Britannia, JMC, Monarch and EasyJet, with technical assistance being provided by BT and several European air traffic service providers. The airlines have equal voting rights within the special purpose vehicle.

On 27 March 2001, the Airline Group was chosen. According to a Government Press Release issued on that day, “Government proceeds are expected to be around £800 million. This deal will also secure over £1 billion of investment in NATS over the next ten years”. NATS was issued with a license on 28 March 2001. On 31 March 2001 NATS ownership was transferred to the UK Government.

3.4.2 TRANSFER OF ASSETS UNDER THE TRANSFER SCHEME

Assets of NATS as a wholly owned subsidiary of CAA were transferred to the PPP company through a statutory act of the UK Government and under powers granted by the Transport Act 2000 (hereafter, the Transport Act).

Chapter II of the Transport Act deals with Transfer Schemes. A transfer scheme under the Act is a scheme which enables the transfer of property, rights or liabilities of the CAA, its wholly- owned subsidiary through the Secretary of State to the PPP company. The transfer may involve a full or partial transfer of the property.

Things that may be transferred under the transfer scheme are clearly set out in the Transport Act and include:

• anything which the transferor would not otherwise be capable of transferring or assigning;

• anything to which the transferor may become entitled or subject after the scheme is made and before it comes into force;

• anything situated anywhere in the UK or elsewhere;

LN1:#20065849 26 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 27 • anything subsisting under an enactment; and

• anything subsisting under the law of any part of the UK or of any country or territory outside the UK.33

A scheme made under the Transport Act may divide any property, impose obligations on a transferor and transferee in order to secure the interests, rights and liabilities transferred.

Schedules 6 and 7 of the Transport Act 2000 further elaborates on the transfer schemes. Among other issues legislated is the effect of a transfer scheme on third parties. The transfer scheme is made in the form of an agreement. Such agreement, made pursuant to the Act and Schedule 6 is binding on all other persons even if it would have required the consent or concurrence of any other person34.

3.4.3 THE ORGANISATION

The PPP construction for the privatisation of NATS has resulted in the creation of a holding company and several subsidiaries.

While assets of NATS as a wholly owned CAA subsidiary were transferred to the NATS Holdings Ltd., the construction resulted in the separation of key operational air traffic services from non-essential air traffic control. The company responsible for essential services - NATS (En Route) Ltd - was licensed under a separate regime.

The result of the PPP is a highly regulated company. The regulation of NATS involves economic, safety, security, and consumer policies alongside normal industry regulations.

At the completion of the PPP transaction on 26 July 2001, the Secretary of State sold 46% of the company to the Airline Group and transferred 5% to the employees under a share scheme. The shares of the government, the Airline Group and the employees were transferred to the holding company – NATS Holding Company Ltd (NHL).

NHL assumed the assets of NATS and all of its subsidiaries. As of this review the subsidiaries of NHL are:

• the National Air Traffic Services Ltd providing corporate services,

• NATS (en route) Ltd –NERL- providing en-route air traffic services,

• NATS (Services) Ltd – NSL- providing air traffic services,

• NATSNav Ltd satellite based navigation, and

• NATS Employee Sharetrust Ltd. serving as administrator of the employee share plan.

These companies are briefly introduced below.

3.4.3.1 National Air Traffic Services Ltd. (NATS)

NATS is the management outfit of the Holding Company and operates all headquarters activities.

33 S. 42 (1), Transport Act 2000 34 Par 19, Schedule 6 to the Transport Act 2000.

LN1:#20065849 27 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 28 The Board of the NATS comprises a non-executive Chairman and 12 directors: CEO, COO, Finance Director, three Partnership Directors (non-executive) and six other non-executive Directors. The Crown Shareholder appoints the three Partnership directors and the Airline Group (AG) appoints the six other non-executive directors, including the International Air Transport Association (IATA) nominee representing the non-AG airlines.

3.4.3.2 NATS (En Route) Ltd. (NERL)

NATS (En Route) Ltd, originally incorporated as 3216th Single Member Shelf Trading Company Ltd., changed its name and was acquired by National Air Traffic Services Limited (NATS) on February 2001.

The company is licensed under the NATS (En Route) Ltd Licence. See section 3.5 below for a detailed review of the licence.

3.4.3.3 NATS Employee Sharetrust Limited (NESL)

The company acts as a trustee in connection with schemes to facilitate the holding of shares in NATS Holdings Limited for the benefit of the employees of that company and any associated companies. It does not trade and has no employees.

At the completion of the PPP on 26 July 2001 6550,000 ordinary shares in NATS Holdings Ltd. (the parent company, representing 5% of its share capital were transferred it by the Secretary of State to be owned by employees or former employees of NATS before the separation.

NATS Employee Sharetrust Ltd. was incorporated on February 2001 under another name. It changed its name on 1 June and was acquired by NATS Holdings Limited on 4 June 2001.

3.4.3.4 NATS (Services) Ltd. (NSL)

NAYS (Services) Ltd provides airport air traffic services at UK airports and sells its expertise and capabilities to overseas customers. Under the transfer scheme assets of this company which were essential for the performance of the duties of NERL were transferred to the Secretary of State and then on to NERL.

NATS (Services) Ltd was incorporated on 21 December 200 under a different name, changed its named on 1 February 2001 and was acquired by National Air Traffic Services Limited

3.4.3.5 NATSNAV

NATSNav Limited is a subsidiary of NATS (Services) Limited (NSL) and was set up on 21 February 2001. It is a member of the European Economic Interest Group (EEIG) acting as a European Satellite Services Provider (ESSP).

AG (46 %) UK Govt. (49 %)

(c) NATS Employee Sharetrust LN1:#20065849 28 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 29

NATS Holdings Co. Ltd (NHL)

(b) National Air Traffic Services Ltd. (NATS)

NATS (En Route) Ltd. NATSNAV Ltd.

(a) NATS (Services) Ltd (NSL)

Figure 1: Company layout: NATS

3.5 NATS LICENCE

On 28 March 2001, pursuant to Section 6 of the Transport Act 2000, the Secretary of State granted NATS a licence35:

• to provide air traffic services in and in respect of the En route (UK) Area from and for the period specified in paragraph 636; and

• to provide air traffic services in and in respect of the En route (Oceanic) Area from the date 31 March 2001 for the period specified in paragraph 737.

The duration of the licence in so far as both the en route (UK) and oceanic areas is concerned is for a minimum period of 20 plus 10 years, if determined by the Secretary of State (Para. 6 and 7). NERL therefore has initial 30 year exclusivity in relation to the provision of Core Services.

35 Air Traffic Services Licence for NATS (EN ROUTE) Limited, Consolidated Version of 1 January 2003. 36 Schedule 1 of the Licence defines the En route (UK) Area to include the following airspace: • London Flight Information Region • London Upper Flight Information Region • Scottish Flight Information Region • Scottish Upper Flight Information Region. 37 Schedule 2 defines the Oceanic Area to consist of the following airspace: • Shanwick Flight Information Region • Area

LN1:#20065849 29 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 30 3.5.1 SERVICES TO BE PROVIDED

Section 8 of the Transport Act defines the duties of the licensee. NATS as the licensee has an obligation to secure that a safe system for the provision of authorised air traffic services in respect of the licensed area is provided, developed and maintained. It addition, the it must take all reasonable steps to secure that the system is also efficient and coordinated. These obligations are clearly elaborated in the Licence issued to NATS.

Condition 2 of the Licence specifies the services NERL is obliged to provide. NERL is required to provide Core Services and Specified Services. Core services are defined in Condition 1 to mean (a) UK En route air traffic control services (b) Oceanic En route air traffic control, (c) Advisory control service, and (d) Terminal approach service. Specified services on the other hand include a list of non-essential services listed in Schedule 4 to the Licence38.

The Core Services may be modified by the CAA or the licensee unless such a modification would have the effect of materially reducing the scope of the UK En route air traffic control service or the Oceanic en route air traffic control service. The right of modification of the sore services and the specified services is further curtailed by business and financial practicalities as well as by operational aspects and international obligations assumed by the UK (see Condition 3)

3.5.2 DISPOSAL OF ASSETS

NERL is not entitled to dispose of any interest which it holds in, or relinquish operational control which it has over any relevant asset without a three month prior written notice to the CAA of its intention to dispose or relinquish control. Paragraph 3 to Condition 5 provides an exception. The exceptions apply generally in cases where the CAA has issued directions containing a general consent to transactions of a specified description or where the disposal or relinquishment is required by or under any legislation.

Irrespective of the approval of the CAA, NERL’s right to (a) create a mortgage, charge, pledge, lien or any other form of security, (b) transfer, lease, licence or lend any sum, and (c) enter into an agreement or incur any commitment incorporating a cross-default obligation are clearly curtailed in the Licence.

3.5.3 REGULATORY ACCOUNTING

NERL is obliged to supply such regulatory accounting information as to enable the CAA to assess its financial position and the financial performance of each separate business and to assist the CAA to assess NERL’s compliance of the licence in respect of its financial relationship with its affiliate or related undertakings (Condition 6). Affiliate undertakings mean NATS Holding and any subsidiary of NERL or of the Holding company such as NSL.

38 Specified Services” in Schedule 4 of the Licence. These include: (a) Aeronautical Messaging Network (b) Air Traffic Operational Telephone Network (c) Emergency Fixing Facility (d) Emergency Frequency Facility (e) Navigational Infrastructure Services (f) North Sea Helicopter Advisory Service (g) Nuclear and Chemical Accident Service (h) Surveillance Infrastructure Services (i) UK Aeronautical Information Service (j) UK Flight Information Service (k) UK Meteorological Information Service

LN1:#20065849 30 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 31 3.5.4 PERFORMANCE INDICATORS AND STANDARDS OF SERVICE

NERL is required under Condition 11 to produce a statement in respect of service performance and standards. The statement must set out measures (including but not limited to delays, service interruptions and complaints) against which the Licensee’s performance and quality of service may reasonably be assessed, performance indicators based on those measures and standards of service to be met by the Licensee.

The statement which is to be revised annually is to be compiled following consultation with users.

It is interesting to note that paragraph 3 of the Condition logically leaves the achievement of performance targets with the licensee. In that paragraph the licensee shall conduct its business in the manner best calculated to achieve standards of service.

In its second annual statement of performance approved by the CAA on 31 May 2002, NATS covered among other issues:

• safety, in particular a definition of airproxes (per 100.000 aircraft movements) and other mandatory occurrence reporting (MOR);

• air service delivery, being capacity provided on an annual basis as well as NATS attributable delay;

• ATS service continuity;

• NATS Customer Satisfaction Index; and

• Oceanic service delivery, where availability is proposed to be set at a service standard of 99.7%.

In addition to the core services, the NERL Licence defines a number of specified services which NERL must provide. NERL reports on engineering performance for Aeronautical Messaging, Air Traffic Operational Telephone Network, Emergency Fixing, Emergency Frequency Facility, Navigational Infrastructure and Surveillance Infrastructure. According to its 2002 Statement, subsequent reports will cover additional issues as:

• General performance/availability;

• Significant outages;

• Any consequent service interruptions; and

• Description of corrective action.

In its policy statement on the enforcement of the licence the CAA recognised the service standards constitute a minimum of what should be regarded as achievable. The service and performance standards are clearly distinct from the optimal service quality targets that the CAA will encourage NERL to achieve through the processes of business planning and price regulation. Despite that, NERL will be sanctioned for failing to achieve those targets.

3.5.5 PAYMENT OF FEES

NERL is required under Condition 18 to pay fees to the CAA. Generally, these include:

LN1:#20065849 31 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 32 • A basic fee, being an annual payment of an amount which is a fair proportion of the total cost to be incurred by the CAA in the regulation and enforcement of the licence;

• An additional fee in excess to cover the Charge Control review process;

• As from 2003, the difference between the basic fee and the actual total cost; and

• Fees in connection with references made to the Competition Commission under Section 12 of the Act.

3.5.6 CHANGES IN SHAREHOLDINGS

NERL is required to notify the Secretary of State whenever an undertaking becomes or intends to become a parent undertaking. A parent undertaking in relation to NERL, as defined in Section 258 of the Companies Act 1985 as substituted by Section 21 of the Companies Act 1989, will include an undertaking which:

(a) holds a majority of the voting rights in the undertaking (NERL);

(b) is a member of the undertaking (NERL) and has the right to appoint or remove a majority of its board of directors;

(c) has the right to exercise a dominant influence over the undertaking (NERL)

(i) by virtue of provisions contained in the undertaking's memorandum or articles; or

(ii) by virtue of a control contract; or

(d) is a member of the undertaking and controls alone, pursuant to an agreement with other shareholders or members, a majority of the voting rights in the undertaking.

The obligation to notify the Secretary arises in those situations where, by reason of that acquisition or change, the total number of shares in that relevant company held by that person otherwise than as trustee or nominee for another person together with any shares held by any nominee or trustee for that person immediately after that change or acquisition (i) exceeds or would exceed 15 per cent of the total number of shares; (ii) exceeds or would exceed 30 per cent of the total number of shares; or (iii) exceeds or would exceed 50 per cent of the total number of shares.

It may be recalled that the UK Government transferred 46% of the shares to the special vehicle company, the Airline Group, retained 49% and assigned 5% of the shares to the employees. Shareholding in the Airline Group is equally split among the members.

The acquisition by one of the members of a controlling stock in the Airline Group will inevitably affect the balance of power carefully designed in the Transport Act. The Secretary of State is therefore charge with the direct responsibility of ensuring that this balance is maintained.

3.5.7 CHARGE CONTROL

Part III of the NERL licence contains detailed provisions on price regulation of NERL’s services. The Charge control conditions set in Conditions 21 to 25 relate to the following sets of revenue:

LN1:#20065849 32 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 33 (a) subject to certain exclusions, that part of the charges paid to by users which is reimbursed to the United Kingdom and relates to services provided by the Licensee;

(b) charges levied by the Licensee in respect of the Shanwick Oceanic Control Area (as described in Schedule 2); and

(c) charges for North Sea Helicopter Advisory Services and Terminal Approach Services.

Condition 21 limits increases in average controlled Eurocontrol revenue. Condition 22 regulates a price cap on average charges in the en-route (Oceanic) area. Condition 23 sets a price cap on charges for special services, including North Sea Helicopter Advisory Services and Terminal Approach services.

The purposes of Conditions 24 and 25 are:

(a) to require the Licensee to give information to the CAA as to its forecasts for the Average Charge Per Service Unit or Average Charge Per Oceanic Flight;

(b) to require the Licensee to submit an annual statement to the CAA containing specified historical information to enable the CAA to monitor the Licensee’s compliance with the Charge Control Conditions;

(c) to make provision for the suspension or modification of all or part of the Charge Control Conditions in circumstances governed by national security directions or in certain other limited circumstances;

(d) to make provision for the suspension or modification of the Charge Control Conditions relating to Oceanic Charges where this is demonstrated to the satisfaction of the CAA to be in the overall interests of users; and

(e) to make provision for the adjustment of the Charge Control Conditions if necessary following a National Security Period.

3.6 LIABILITY

NATS Holding Company and all of its subsidiaries are limited liability companies. Members of the companies are therefore liable for the operations of the companies. The licensed company –NERL- is however immunised for part of its activities. Under the Transport Act 2000, no action shall lie in respect of a failure by the licensed company a duty imposed by Section 8 and a condition of a licence.

It is not immune from actions in respect of an act or omission which takes place in the course of the provision of air traffic services. Indeed according to its Annual Statement of account the group received several claims in 2000 due to flight cancellations and delays which arose as a consequence of three incidents with the National Airspace System.

3.7 MONITORING AND ENFORCEMENT

The monitoring of NERL under the Transport Act 2000 and the enforcement of its compliance with the licence is the responsibility of a number of institutions identified above, namely:

• the Secretary of State;

LN1:#20065849 33 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 34 • the CAA, through the Economic Regulatory Group (ERG) and the Safety Regulatory Group (SRG);

• the Competition Commission; and

• the Ministry of Defence through the CAA’s Directorate of Airspace Policy.

By and large the largest regulatory responsibility lies with the CAA as the aviation expert organ of the State. The CAA monitors and enforces NATS compliance through the Licence Manager and the NATS Licence Management Coordination Committee (NLMCC). The Licence Manager has general responsibility for day-to-day licensing matters. The NLMCC is a sub-committee of the CAA Board. It comprises senior staff representatives from ERG, DAP, SRG and the CAA’s Legal Department. Its purpose is to monitor, review progress and keep the CAA’s Executive Committee (and through that the CAA Board) informed on licence monitoring and enforcement activities generally. The NLMCC is responsible for taking decisions on licensing matters that involve the material interests of more than one of the three regulatory groups of the CAA.

3.7.1 REGULATORY INSTRUMENTS

The NATS licence provides for two quite separate approaches to achieving this end. The first is through the use of incentive-based regulation and the second through the laying down of fixed requirements backed by sanctions.

The CAA’s general approach to regulation is to favour incentives over sanctions wherever possible. By this means it seeks to ensure that the objectives of the regulated company are as closely aligned as possible to those of its users. In the longer term, the CAA’s aims to develop the incentive properties of the price cap to the point where it can become the principal means of motivating NATS to address the needs of its users, particularly with respect to capacity and service quality. Thus the CAA sees the incentivisation of NERL through the price cap conditions and consultation between NERL and its users on the basis of appropriately specified forward looking business plans (under Condition 10) as the main instruments for addressing the basic Condition 2 obligation to make available the Core Services so as to be capable of meeting any reasonable level of overall demand.39

3.8 CONCLUSION

The privatisation of NATS was undertaken as a PPP with government retaining 49% of the shares of the previously state owned company – NATS.

The NATS PPP was facilitated through and Act of Parliament (the Transport Act 2000) and a licence issued by the UK CAA to the licenced company.

The process resulted in the transfer of 46% of government shares to the Airline Group Ltd. a holding company for participating UK airlines, and 5% to the employees of NATS.

While Government is not involved in the day to day management of the company, Government reserved the right to nominate three non-executive members of the NATS Board. The Airline Group also nominates 6 non-executive members of the Board.

39 UK CAA, The CAA’s Policies the policies towards the monitoring and enforcement of The NATS en route ltd (NERL) licence.

LN1:#20065849 34 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 35 The public oversight of NATS is undertaken by the Secretary of State, through his nominees on the Board of the company, but most importantly through the economic and safety regulation of the UK CAA. In addition, the joint monitoring of the CAA and the Department of Defence through the Directorate of Airspace Policy ensures that civil-military interface is indeed harmonised.

In terms of service guarantees and service performance, while NATS does not make any specific service guarantees, it is obliged under the terms of the NERL Licence to provide a service and investment plan as part of the 5 yearly Business plan. This plan and the statement of performance indicators, coupled with the obligation to consult with users ensures that the CAA is able to monitor safety indicators and performances of the company.

While NERL is immunised for non-performance of certain obligations, it is liable for acts or omissions resulting in damages. As indicated in the Groups Annual Statement for 2002, claims have been deposited against the company as a result of certain delays in June 2001.

NATS PPP offers a number of options to the PPP of Galileo. These are:

(a) the detailed and systematic structure ensures transparency and clarity;

(b) while the Board of the Holding Company (NHL) is not different from the managing company (NATS), the separation of company management from shareholding issues enhances the efficiency of the company’s operations;

(c) the regulatory mechanism adopted under the UK PPP, i.e. a separate economic, safety and civil-military interface regulation, albeit through a single point of contact in the CAA, makes for a transparent and reliable oversight programme; and

(d) the concept of price cap regulation, while complex and acceptable within the UK legislation, may be worth considering for its suitability within a European wide system.

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4 NAV CANADA

4.1 INTRODUCTION

The Canadian land mass stretches from the Arctic Ocean to the border of the United States and from the Atlantic Ocean to the Pacific Ocean. A sophisticated civil air navigation has been built over the years to cover this vast terrain. In 1995 the Canadian Air Navigation System (ANS) comprised seven area control centres (ACCs), 55 control towers and 105 flight service stations (FSS) which were complemented by seven military control centres and 13 military control towers operated by the Canadian Department of National Defence. The ANS employed about 6,000 people directly and another 1,000 in support functions. The Canadian airspace then accommodated over six million aircraft movements annually.

Since 1 November 1996 those services are managed by NAV Canada.

Authority for the transfer of air navigation services, the economic and safety regulation of the privatised air navigation services operator and monitoring of its activities are reserved to two Governmental agencies, namely: the Minister of Transport and the Canadian Transportation Agency

This section analyses the privatisation of the Canadian ANS and the transfer of assets to Nav Canada. This analysis does not explain the rationale for the commercialisation of the air navigation services as that issue is not considered of any use to Galileo.

4.2 THE PUBLIC AUTHORITY

In international air law, responsibility for the management of a state’s airspace lies with the government of the state. Until 1 November 1996 the civil air navigation services within Canadian airspace and within the airspace over which Canada has the responsibility for the provision of air traffic control services were managed and provided by the government of Canada through its Department of Transport.

Since the commercialisation of the air navigation services, the service provision function is undertaken by Nav Canada. The Government of Canada remains responsible for air navigation legislation both in terms of safety and economy.

4.2.1 MINISTERIAL AUTHORITY

The commercialised air navigation services corporation, Nav Canada, is responsible to the Minister of Transport. The legislation gives the Minister a dual role in a sense as both represented on the board of the corporation and as a regulator of the corporation on matters of policy. Whereas in some jurisdictions Government owns shares in the corporation (New Zealand is for instance the sole shareholder in the government ATC corporation, Airways New Zealand) Nav Canada is an autonomous ATC corporation with no government ownership.

In relation to the provision of air navigation services, the Aeronautics Act (R.S. 1985, c.A-2) and the Civil Air Navigation Services Commercialisation Act (hereafter, ANS Act) are the governing instruments.

LN1:#20065849 36 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 37 Under Section 4.2 of the Aeronautics Act, the Minister of Transport “is responsible for the development and regulation of aeronautics and the supervision of all matters connected with aeronautics and, in the discharge of those responsibilities, the Minister may:

(a) promote aeronautics by such means as the Minister considers appropriate;

(b) construct, maintain and operate aerodromes and establish and provide other facilities and services relating to aeronautics;

(c) establish and provide facilities and services for the collection, publication or dissemination of information relating to aeronautics and enter into arrangements with any person or branch of government for the collection, publication and dissemination of that information;

(f) establish aerial routes;

(h) take such action as may be necessary to secure by international regulation or otherwise the rights of Her Majesty in right of Canada in international air traffic;

(j) cooperate or enter into administrative arrangements with aeronautic: authorities of other governments or foreign states with respect to any matter relating to aeronautics; and

(n) investigate matters concerning aviation safety

The Minister of Transport under the ANS Act, has the power “to sell, lease or otherwise transfer the right, title and interest” of Canada in civil air navigation services.

The sale of Canadian air navigation services to Nav Canada and the economic and safety regulation of that company is accordingly organised on the basis of the legal authority described above.

On the basis of the Ministerial authority for air transport, Transport Canada is granted specific powers under the ANS Act. These include the power to issue public service directions for the provision of services over remote territories40, the power of approval of charges amended within 2 years of transferring ANS assets to Nav Canada41, and the power to approve letters patent and special sections of the by-laws of Nav Canada42.

4.2.2 THE CANADIAN TRANSPORT AGENCY

The Canadian Transportation Agency (hereafter, the Agency) is an independent, quasi- judicial tribunal that makes decisions on a wide range of economic matters involving federally- regulated modes of transportation (air, rail and marine), and has the powers, rights and privileges of a superior court to exercise its authority. Along with its roles as an economic regulator and an aeronautical authority, the Agency works to facilitate accessible transportation, and serves as a dispute resolution authority over certain transportation rate and service complaints.

The Canada Transportation Act is the Agency's enabling statute to implement the federal government's transportation policy.

41 ANS Act, Section 39 42 ANS Act, Section 86.

LN1:#20065849 37 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 38 In air transport, the Agency handles general consumer issues and complaints related to air travel. It is also responsible for the licensing system for air carriers who provide domestic or international publicly available air transportation services and for the enforcement of the Canada Transportation Act and its related regulations. As well, the Agency administers a permit system for international charter operations, helps negotiate and implement bilateral air agreements and administers international air tariffs.

Under the ANS Act, the Agency is granted specific powers of oversight in relation to the filing of new charges announced by the corporation43 and appeals against such charges.

4.3 THE CORPORATION

Nav Canada was incorporated as a non-share capital corporation under the Canada Corporations Act on 26 May,1995.44 With a few exceptions, Nav Canada is the only corporation authorised to provide civil air navigation services previously provided by the Department of Transport. 45 It is moreover designated as the authority in Canada responsible for providing aeronautical information services and air traffic control services for the purposes of Annex 4, 15 and 11 of the Chicago Convention46. The Corporation is a typical monopoly service provider.

The company has the right to plan and manage Canadian airspace for the provision of air traffic control services other than airspace under the authority of the minister of defense47, and may introduce, increase, terminate or reduce civil air navigation services48.

In spite of the mandate it is important to note that Nav Canada is not an agent of the State nor does it provide air navigation services on its behalf.49 The Corporation is a private not-for- profit organisation incorporated under the Canada Corporations Act as a non-share capital corporation. It has financial independence and purchased the Canadian air navigation services on 31 October 1996 for an amount of $1.5 billion.

4.3.1 GOVERNANCE

Measures to establish an appropriate form of corporate governance are found in the corporations Letters Patent and By-Laws as well as in the ANS Act.

Nav Canada’s corporate structure reflects a consensus reached among the stakeholders: government, employees, air carriers and other users of the air navigation services.

Nav Canada letters patent sets out objects of the Corporation which are generally to acquire, own, manage, operate and develop the air navigation services in and over Canada. Nav Canada’s by-laws set out the corporate governance structure for the Corporation.

The Corporation has four voting members who appoint certain of the directors of the Corporation. The members represent the key stakeholder interests. They are the Government Member (appointed by the Minister of Transport), the Union Member and two user Members. These appoint 3, 2 and 5 Members respectively to the Board.

43 S. 36 ANS Act . 44 Preamble, ANS Act 45 S.9 & 10 ANS Act 46 S.11 ANS Act 47 S.13 ANS Act 48 S. 14 ANS Act 49 S.8 ANS Act

LN1:#20065849 38 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 39 Nav Canada is consequently governed by a fifteen-member board of directors composed of airlines (4), general aviation (1), federal government (3) and unions (2). These ten then appoint four independent directors and the board appoints the president and chief executive officer.

The uniqueness of the governance structure of this organisation is the fact that paying customers appoint a third of the Board. This is known to mitigate the level of concern customers may normally have with a monopoly service provider.

4.3.2 OWNERSHIP AND CHARGES

Nav Canada has no shareholders. The four board members, representing the Air Transport Association of Canada, the Federal Government, ANS Union Association and Business Aircraft Association, and who appoint the other ten eventually act as surrogate shareholders in that they appoint the Board of Directors, approve corporate By-law changes and appoint auditors.

As a non-share capital corporation, Nav Canada’s capitalisation for the acquisition of the ANS and all subsequent financial requirements are debt financed. The corporation’s debt is not guaranteed by the tax payer.

The corporation is financially independent, and responsible for the operation, maintenance and capital requirements of the Canadian air navigation services. The ANS Act gives it the right to recover all of its costs through user chares. It operates on a cost service basis whereby the costs of its services are recovered in revenues from its customers50. It is important to note that a transitional regime was introduced in the ANS Act enabling Nav Canada to secure government grants for a maximum period of 2 years. Prior to the transfer the primary sources of revenue for air navigation services provided by Transport Canada were the Air Transportation Tax and international overflight charges. Under agreement with the government, and pursuant to Section 33 of the ANS Act, Nav Canada was to retain charges existing before the transfer. Accordingly the government provided for monthly grants to a maximum of $ 1.44 billion to be paid to Nav Canada during this two year period until it put new charges in place51. The grants represented governments anticipated revenues.

Pursuant to the ANS Act and its Letters Patent the Corporation is to carry on its operations without pecuniary gain to its members.

Nav Canada is not permitted by statute to generate revenues in excess of its financial requirements. These requirements are clearly specified in Section 35 (5) of the ANS Act to include:

(a) costs incurred before the transfer date;

(b) operations and maintenance costs;

(c) management and administration costs;

(d) debt servicing requirements and financial requirements arising out of contractual agreements relating to the borrowing of money;

(e) depreciation costs on capital assets;

50 S. 32 (1), ANS Act. 51 S. 98, ANS Act

LN1:#20065849 39 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 40 (f) financial requirements necessary for the Corporation to maintain an appropriate credit rating;

(g) tax liability;

(h) reasonable reserves for future expenditures and contingencies; and

(i) other costs determined in accordance with accounting principles recommended by the Canadian Institute of Chartered Accountants or its successor.

4.3.2.1 Benefits of non-share capital/trust model

It needs to be noted that Canada chose to privatise by way of a non-share capital model for the following reasons:

• Conflict of interest: This model eliminates any perceived conflict between personal profits and safety. It may be recalled that Nav Canada profits are recycled to a) pay debt, b) finance capital expenditures or c) reduce service fees.

• Stakeholder representation: This model allows for stakeholder representation on the Board. Indeed this model has been carefully examined by analysts and the conclusion is that the representation of key stakeholders on the Board is a major factor to the successful capitalisation of the corporation. Airlines do not feel overcharged since they are involved in decision making. The “AA” credit rating of Nav Canada by Canadian and US rating agencies has largely to do with the confidence of the consumer.

• Public Interest: As the custodian of the public interest the Canadian government is actively involved as a key Board member and moreover retains the right of approval of key amendments in the By-laws including the membership of the board. The right of government to the assets of the corporation following dissolution or bankruptcy also goes a long way to guarantee efficiency.

• Natural monopoly: as provided for in Section 10 of the ANS Act, Nav Canada is a natural monopoly. This position enhances the capacity of the corporation to plan the modernisation of the air navigation services and the provision of such services to the customers.

• Independent procurement policies: As a financially independent corporation, the Canadian government does not get itself involved in procurement policies of Nav Canada.

Other advantages are:

• economically self-regulating company;

• government as a safety regulator;

• directors subject to common law obligations as fiduciaries to act in good faith and in the best interests of the corporation; and

• conflicts avoided in that Board appointees cannot be employees, officers or directors of significant customers or elected officials or employees of government.

LN1:#20065849 40 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 41 4.3.3 MONITORING

In addition to the accountability built in through the governance structure examined above, accountability in law is maintained through regulation of the corporation from a safety perspective, under the Aeronautics Act and the Canadian Civil Aviation Regulations and economically under the ANS Act.

4.3.3.1 Economic Regulation

In the field of economic regulation, it needs to be remembered that Nav Canada is a monopoly in the provision of air navigation services. Other than the first two years after the transfer of the Canadian ANS to Nav Canada, the Minister plays no role in the regulation of the charges imposed by Nav Canada. It is indeed a market regulated pricing policy since the prices are set by Board Members including representatives of carrier users. From that perspective, the right assumed by the Minister to approve substantial amendments of the letters patent and By-laws is a major economic regulatory power since the role of the Board is essential in the process of charging and its implementation.

4.3.3.1.1 Charges

Prior to the privatisation of the Canadian ANS, the Minister had the authority to impose charges for the availability during flights of any facility or service provided on behalf of the Minister.52 Subsequent to the transfer of the ANS to Nav Canada, charges may however be imposed by NAV Canada on a user for the availability or provision of air navigation services it provides.53

The ANS Act contains regulates in detail the right of Nav Canada to charge for ANS services. Within the period immediately following the transfer, charges imposed by Transport Canada were to be retained (S. 33). This was for a period of two years. Subsequent to the transfer Nav Canada was entitled to revise charges.

Section 35 provides a detailed list of principles governing the establishment of new charges or revising an existing charge:

(a) charges must be in accordance with a methodology established and published by the Corporation that is explicit and that also includes the terms and conditions affecting charges;

(b) charges must not be structured in such a way that a user would be encouraged to engage in practices that diminish safety for the purpose of avoiding a charge;

(c) charges for the same services must not differentiate between domestic and international flights of air carriers;

(d) charges for the same services must not differentiate among Canadian air carriers or among foreign air carriers;

(e) charges must differentiate between the provision of services in relation to the landing and take-off of aircraft and the provision of services in relation to aircraft in flight, and must reflect a reasonable allocation of the costs of providing the services in those circumstances;

52 S. 4.4 Aeronautics Act. 53 S. 32 (1) ANS Act

LN1:#20065849 41 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 42 (f) charges in respect of recreational and private aircraft must not be unreasonable or undue;

(g) charges for designated northern or remote services and for services directed to be provided under subsection 24(1) must not be higher than charges for similar services utilised to a similar extent elsewhere in Canada;

(h) charges must be consistent with the international obligations of the Government of Canada; and

(i) charges must not be set at a level that, based on reasonable and prudent projections, would generate revenues exceeding the Corporation's current and future financial requirements in relation to the provision of civil air navigation services.

As noted earlier, the financial requirements (established as a principle in (i) above) of the company are also carefully circumscribed by the ANS Act to include:

(a) costs incurred before the transfer date;

(b) operations and maintenance costs;

(c) management and administration costs;

(d) debt servicing requirements and financial requirements arising out of contractual agreements relating to the borrowing of money;

(e) depreciation costs on capital assets;

(f) financial requirements necessary for the Corporation to maintain an appropriate credit rating;

(g) tax liability;

(h) reasonable reserves for future expenditures and contingencies; and

(i) other costs determined in accordance with accounting principles recommended by the Canadian Institute of Chartered Accountants or its successor, to the extent that they relate to the provision of those services, less the amount determined in accordance with subsection (6).

The nearest to a role played in the monitoring of the prices comes from the Agency . Nav Canada is in accordance with Section 36 (3) of the ANS Act obliged to file notices with the Agency when changing or revising prices. Such charges can then be appealed to the Agency by aggrieved users. It is also worth noting that within the two year transitional period, special Ministerial approval was required for the amendment of charges existing prior to the transfer54.

4.3.3.2 Safety Regulation

The minister of transport is responsible for the development and regulation of aeronautics and the supervision of all matters connected with aeronautics. In the discharge of his duties, the

54 S. 39, ANS Act.

LN1:#20065849 42 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 43 minister may take any action that is necessary to secure the rights of the State in international air traffic.55

4.3.3.2.1 Level of Service, Changes to services and facilities

Under the Aeronautics Act, the Minister is authorised to direct Nav Canada to maintain or increase the level of civil air navigation services56. With respect to northern or remote locations, the Minister may issue public obligations directives requiring Nav Canada to provide air navigation services.

Subject to this general provision however, Nav Canada has the freedom to determine its own level of service policies. Indeed Article 23 of the ANS Act provides that The corporation shall within one year after the transfer date, establish policies concerning the levels of civil air navigation services it provides, apply it consistently and revise it from time to time. Nav Canada is under no obligation to provide additional services in excess of the levels provided for in its level of service policies unless it is establish by written evidence that a majority of users who will be affected by the provision of the additional services agree to the provision of the additional services. Naturally the provision of any such services will attract additional charges.

In addition to the right to the independence to set its own policies, Nav Canada may introduce or increase, terminate or reduce civil air navigation services, close or relocate facilities used.57

55 S. 4.2 (h) Aeronautics Act 56 S. 4.91, Aeronatics Act 57 S. 14, ANS Act

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5 THE DEFENCE FIXED TELECOMMUNICATIONS SYSTEM (DFTS)

5.1 BACKGROUND

In July 1997, the Ministry of Defence (MoD) awarded a 10-year contract under a Private Finance Initiative (PFI) to British Telecommunications plc (BT) for the provision of a new Defence Fixed Telecommunications System (DFTS). The system, which is for the whole of the MoD, including the three armed forces, replaced 46 distinct services, provided by four separate organisations within the MoD. The new system consists of six services managed by one organisation, the Defence Communications Services Agency (DCSA). The system became operational in mid-2000.58

The PFI implemented one of the world’s largest virtual private telecommunications networks and included the development of a secure Internet service.59 The PFI was intended to cut the cost of fixed telecommunications to the MoD, without any reduction in operational effectiveness or quality of service to the end user.60

During the first three years (1997-2000), BT was responsible for operating the existing fixed telecommunications service while preparing its system to take over the service, a process known as migration, by July 2000. The new services were introduced according to specified milestones.61

5.1.1 APPROACH IN THE SELECTION OF THE PRIVATE SERVICE PROVIDER

Since 1982, MoD studies of its fixed telecommunications had identified scope for financial savings and operating efficiencies by creating a single fixed telecommunications system.62 In May 1992, the MoD endorsed an internal review, which defined the scope of the DFTS and provided the basis for placing the fixed telecommunications systems of the three armed services under unified control.

In 1993, the MoD commissioned GPT, a telecommunications supplier, to identify various ways of rationalising the MoD’s fixed telecommunications into a single system. GPT examined the costs, benefits and risks of this option over a 15-year period against the alternative of maintaining the existing method of service provision. The study, called the Project Definition Study (PDS), was completed in 1994.63 BT also took part in the PDS. The study found that a potential reduction of 20 per cent or more in the MoD's ongoing operating costs could be achieved if the DFTS was implemented.

In late 1994, the MoD advertised for expressions of interest in the project in the Ministry of Defence’s Contracts Bulletin and Government Opportunities. At this point, the project was based on implementing a so-called hybrid option using publicly funded, asset-based procurement. The MoD received expressions of interest from 16 companies in the industry.

58 para 1, Public Accounts Committee. Twenty-Sixth Report. 59 p. 81, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 60 para 2, Public Accounts Committee. Twenty-Sixth Report. 61 p. 5, NAO Report. 62 p. 12. NAO Report. 63 p. 15, NAO Report.

LN1:#20065849 44 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 45 Based on replies to a pre-qualification questionnaire, the MoD identified six firms they believed had the technical, financial and managerial ability to deliver its requirements: BT, Racal, GPT, Nortel, EDS and Mercury Communications Ltd.

In March 1995, the MoD published an initial Cardinal Points Specification (CPS) and invited the six companies to submit firm priced proposals for the implementation and operation of the DFTS.64 The CPS was a requirements oriented specification, i.e., one which left open a number of possible technical solutions. It was in fact a large and detailed document reflecting the complexity of the requirement and the extensive existing networks. Two of the companies, EDS and Mercury Communications Ltd, withdrew from the competition without submitting a bid.

The invitation to tender (ITT) was based on traditional asset-based procurement. The MoD supplied bidders with a spreadsheet model of their estimates of the costs of continuing to operate fixed telecommunications under the existing arrangements over a 10-year period. It asked bidders to provide their own estimates of the costs to the MoD on that model, to ensure that bids were received in a consistent format to assist fair comparison. There was no formal decision to procure the project through a Private Finance Initiative, although the ITT encouraged bidders to offer innovative solutions, including PFI.65, 66

In rationalising its existing fixed telecommunications services, the MoD aimed to achieve financial savings of around £30 million a year (some 20 per cent of their annual fixed telecommunications costs).67

The MoD received four bids in response to its ITT in June 1995.68 Two of these, from GPT and Nortel, were for traditional asset-based implementation of the system, i.e., a traditional procurement where the MoD buys in what it needs, operates the system and provides the service. The other two, from BT and Racal, proposed privately financed solutions whereby they would implement and manage the new system. They proposed to charge for most telecommunications services on a tariff basis, so that the MoD’s payments would be more closely related to usage than under the previous arrangements where it leased lines from telecom companies.

The MoD decided during the competition that a privately financed solution was the most promising solution. The Treasury’s Private Finance Panel designated the DFTS as a “Pathfinder” project in late 1995, which meant that it was a private finance project in a new area from which lessons could be learned. The MoD subsequently reflected lessons from this project in guidance which they issued in 1998.69

The MoD selected BT and Racal to submit further bids to examine privately financed options more thoroughly. Negotiations and three further rounds of competitive bidding took almost two and a half years.70 The scope of the project changed as competition progressed and so too did the cost estimates.71

64 p. 81-82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 65 para 8, Public Accounts Committee. Twenty-Sixth Report.. 66 p. 18, NAO Report. 67 p. 1, NAO Report. 68 p. 27, NAO Report. 69 p. 19, NAO Report. 70 p. 82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 71 p. 17, NAO Report.

LN1:#20065849 45 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 46 The MoD selected BT as the preferred bidder in November 1996. The MoD began exclusive negotiations with BT which were to last for nine months until the contract was signed in July 1997. The terms negotiated during this period included the details of price indexation, compensation for poor performance, and the arrangements for a further competition at the end of the contract period. The MoD obtained some changes in their favour and conceded on others. While the level of concessions was not unreasonable, there were some potentially onerous terms, tabled earlier by BT, which remained unchanged.72

The MoD estimated that the project would cost £782 million (present value),73 consisting of £612 million in payments to BT, and £170 million in other costs remaining with the MoD. The MoD estimated that its contract with BT, together with cost reductions it had made before letting the contract, would achieve the 20 per cent savings target established in 1995,74 i.e., that it was £44 million cheaper than its 10-year budget provision for fixed telecommunications services. This had been reduced to take account of savings of 20 per cent (around £30 million a year identified in the MoD’s 1994 review).

According to MoD estimates, BT’s final bid was £121 million (expressed in present values) less costly than the final bid from Racal. BT’s final bid also produced non-financial efficiencies and innovations compared to the previous form of service delivery.75

Although BT’s price rose by £77 million during the subsequent negotiations, this was largely a result of BT agreeing to provide additional services and to advance the date for taking over some services. The MoD were able to reduce other costs associated with the project which largely offset the price increase.

BT established a dedicated prime contract management organisation, called INCA, to operate the DFTS on behalf of the Ministry of Defence. INCA is now known by the rather longer name of BT Ignite Solutions Defence. BT as the prime contractor has three major sub-contractors, namely;

• Lockheed Martin, which provides programme management and systems integration expertise;

• GEC Marconi Secure Systems, experts in the areas of security;

• GPT Strategic Communication Systems, responsible for the UNITER system76.

With the DFTS programme now well into its sixth year of operation, the emphasis of the work is on the continued delivery of high quality, value for money services by BT. At the same time, there is a continuing need to adapt the DFTS 'business' to new customer requirements and rapidly advancing technology, within the strategic terms of the initial deal.77

72 p. 36, NAO Report. 73 BT Defence website says: “Currently worth an estimated £1.4 billion over ten years, the Defence Fixed Telecommunications Service (DFTS) contract between BT and the Ministry of Defence (MoD) is delivering excellent Value for Money within a restricted capital budget. Both the National Audit Office (NAO) and the Public Accounts Committee have verified that DFTS is already saving the MoD over £30 million a year.” Asked about the discrepancy between the MoD figure and the BT figure, DCSA commented via e-mail 25 Feb 2003: “The BT figure probably is not NPV, but also takes account of growth in requirements since the contract was let. The £782M is the NPV baseline at contract let.” 74 p. 1, NAO Report. 75 p. 3, NAO Report. 76 UNITER is an MoD bespoke secure system, which has electro-magnetic pulse protection which provides security of telecommunications in the event of a nuclear attack. 77 p. 82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk.

LN1:#20065849 46 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 47 5.2 INSTITUTIONAL STRUCTURES

5.2.1 FORM OF THE PUBLIC AUTHORITY

The Public Authority for the DFTS contract is the UK Ministry of Defence. An Integrated Project Team (IPT 160), within the Defence Communications Services Agency (DCSA), discharges the Authority’s responsibilities on a day-to-day basis. DCSA is an MoD executive agency within the Defence Logistics Organisation (DLO).78 An IPT is a team which includes all the relevant expertise, i.e., technical, legal, procurement, financial. Frequently private sector consultants are part of the team. The IPT includes staff who had contributed to the drafting of the DFTS contract in order to avoid “memory loss” between those who negotiated the contract and those who responsible for administering it.

The JU/EC/ESA should consider creating the equivalent of an IPT, which would combine a multi-disciplinary set of expertises, including those involved in negotiating the Galileo concession as well as those who would administer it. The IPT should either include representatives from whoever wins the concession or the IPT could form another committee with representatives from the concessionaire. In either scenario, the task of the IPT or joint committee would be to monitor on a regular basis the performance of the concession and to take those actions necessary to resolve any disputes, disagreements or problems arising.

The MoD side of the DFTS partnering arrangement has evolved considerably since 1997. The DCSA was formed in April 1998 and was put in charge of managing the MoD’s telecommunications, including delivery of the DFTS and liaison with BT.79 In 2000, the IPT underwent a mandatory Smart Procurement Initiative (SPI) breakthrough process, which focused on strengthening the partnership with BT and on organisational improvements within MoD.80, 81 These changes were part of overarching MoD-wide initiatives, to modernise the structure of the Ministry by creating agencies with functional responsibilities and to improve the efficiency of procurement.

5.2.2 THE WAY REGULATORY FUNCTIONS ARE DEALT WITH

BT is responsible for all day to day operations of the DFTS, while the MoD retain an oversight and supervision role.82

The services provided by British Telecommunications plc (BT) under the DFTS contract are regulated by the Office of Telecommunications (Oftel), the UK telecommunications regulatory authority. The UK Telecommunications Acts contain clauses allowing particular powers to be exercised by the DCSA for the defence of the realm, but these are not invoked in routine delivery of DFTS services. 83 All DFTS services are fully compliant with Oftel regulation. It

78 DCSA memo, 20 Dec 2002. 79 p. 9, NAO Report. 80 The Strategic Defence Review (SDR) introduced the launch of the Smart Procurement Initiative - a change programme designed to transform processes and organisational structures with the aim of making the procurement of defence equipment faster, cheaper and better. The Smart Procurement Initiative was renamed Smart Acquisition in October 2000 to stress the point that the MoD is concerned not only with buying equipment, but with acquiring the means to support it throughout its in-service life. This programme has an associated target of reducing acquisition costs by £2 billion over the period 1998 to 2008. See www.intellectuk.org/sectors/defence/smart_acquisition_initiative.asp. 81 p. 82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 82 p. 82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 83 DCSA memo, 20 Dec 2002.

LN1:#20065849 47 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 48 would be possible for MoD to claim “defence of the realm” exemptions, but that has not been necessary and is not seen as desirable.84

By its very nature, the DFTS is different from the public services offered by BT and other telecom operators who are required to provide certain public services and who carry other obligations as conditions of their licences. The DFTS is a straight business relationship between one business and another. As such, there are no public service obligations. Nevertheless, the DCSA, as part of the MoD, is subject to Parliamentary oversight and its budget is approved by Parliament.

5.2.3 NECESSITY OF AN INDEPENDENT MONITORING BODY

Like any other major procurement by the MoD, the DFTS contract is subject to scrutiny both by independent audit offices within MoD and by the National Audit Office.85

The DFTS was one of the first PFI contracts to be let by a government department. This led to scrutiny by the independent National Audit Office (NAO) and the Public Accounts Committee (PAC), both of which report to Parliament and both of which prepared detailed reports on the contract. (The PAC is composed of members of Parliament.)

The findings of the NAO were published in March 2000. The following month, the Public Accounts Committee examined the value for money secured by the deal, the way the MoD negotiated the deal, including the extent of the risks transferred, and how the MoD approached the development of a privately financed project in the fast changing telecommunications sector. The Public Accounts Committee took evidence from the MoD and BT on the letting of the contract and the reasoning behind the decisions that were made.86

The NAO carried out benchmarking which confirmed that the prices of services were generally reasonable. The MoD is paying about the same amount for two high security services as it was before the contract.87 The NAO said the MoD did not establish that the contract with BT would be better than traditional procurement. 88

Apart from the review by the NAO and PAC, there is no on-going independent oversight of the deal. Nevertheless, the DCSA as a component of MoD files annual reports to Parliament, and the NAO then scrutinises those accounts as it sees fit. The Public Accounts Committee has indicated that it would review how the DFTS contract has been implemented before the end of the 10-year contract period.89

5.2.4 PUBLIC SECTOR REQUIREMENTS IMPOSED ON THE PRIVATE ENTITY

Most of the requirements placed on BT, which are specific to the provision of services to MoD, relate to security. The extent of these requirements varies depending on the service provided; some services have relatively minor enhancements over normal commercial telecommunications, others have extensive specialised features such as strong encryption.90

84 e-mail from DCSA, 21 Jan 2003. 85 DCSA memo, 20 Dec 2002. 86 p. 82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 87 p. 4, NAO Report. 88 p. 24, NAO Report. 89 See Question 13. Minutes of Evidence. Taken before the Public Accounts Committee. 5 April 2000. 90 DCSA memo, 20 Dec 2002.

LN1:#20065849 48 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 49 The contract provides for a further competition towards the end of the contract period and arrangements for this competition have to be put in hand from the eighth year onwards. The contract requires BT to make certain information available to enable a full and open competition. This information does not include data on BT’s methods and mechanisms for delivering the services, which is commercially sensitive.91 At this stage, many of the procedures and associated costs for the further competition have yet to be worked out.92 The important recompetition principles, e.g., the transfer payments and provision of recompetition data, are, however, built into the existing DFTS contract. Detailed recompetition procedures, e.g., how the competition is run, will depend on prevailing MoD and Treasury policy at the time.93

The EC/ESA/JU must decide what information they expect the concessionaire to make available at or near the end of its term. This information requirement should form part of the initial concession contract. They should build into the contract all the measures necessary to ensure that an effective competition is possible. In doing so, the contract should include a recognition that the procedural aspects of the re-competition will be subject to the organisational and political framework in which the EC operates at the time and, as a consequence, it is not possible to specify that framework at initial contract let.

5.2.5 OWNERSHIP OF ASSETS

It has been said that the PFI has brought about a huge cultural change in government departments. DFTS, in particular, has transformed the MoD from being an owner of assets and a direct provider of services to a purchaser of those services from the private sector. This, in itself, divides and directs the skills of each sector appropriately: the private sector owns and manages the assets under the PFI and, in return, the public sector obtains better quality, value for money services. In this way, the PFI reduces public spending.94 Letting the private sector decide how it can best deliver services allows the greatest scope for private sector innovation in service delivery.

As far as possible, the assets used to deliver DFTS services are owned by BT, so that BT is fully responsible and accountable for all aspects of service quality and performance. At the start of the contract, the majority of MoD’s fixed telecommunications assets in the UK were sold to BT for a nominal price (£1); the final competitively tendered price was based on that expectation. For security reasons, MoD retained certain specialised equipment items, but the number and value of these is progressively reducing, as contractual mechanisms are devised to allow their ownership and management by BT. 95 Although the MoD retained ownership of its UNITER and BOXER systems, BT maintains and operates these.96

If BT fails to win the next contract, the new supplier will only pay BT £1 for any of the assets which remain at the end of the contract period. It is unlikely, however, that many of these assets will remain as BT is expected to undertake extensive investment and modernisation of equipment. 97

For those assets and equipment that have been introduced by BT and that the new supplier chooses to use, BT will receive payments, known as transfer payments, from the new

91 p. 53, NAO Report. 92 p. 52, NAO Report. 93 E-mail from DCSA, 25 Feb 2003. 94 p. 81, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 95 DCSA memo, 20 Dec 2002. 96 p. 19, NAO Report. BOXER is an MoD bespoke secure telecommunications system which provides the network to carry the UNITER secure telecom system (see footnote above). 97 p. 53, NAO Report.

LN1:#20065849 49 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 50 supplier. Although the new supplier will select which, if any, service assets it wishes to purchase, if it does choose to use some of the existing assets for a particular service, it must buy all of the assets for that service. The transfer payments for assets and equipment introduced by BT will be based on specified percentages of the annual charge for the relevant service in the ninth year of the contract. Based on estimates of spending in 1999/2000, transfer payments for all assets and equipment for all telecommunications services would be £43 million, some 30 per cent of the total annual spend on the contract. 98

The DFTS transfer payment arrangements merit close study by the EC and/or JU since it may wish to develop comparable arrangements for the transfer of Galileo assets at the end of the concession contract to another prospective concessionaire.

5.2.6 SECURITY STRUCTURES

As one might expect, security has played an important role in the deployment of the DFTS from the beginning. MoD was exempted from advertising the competition in the Official Journal of the European Communities and from following European Union procurement rules as the project contained elements concerning national security.99

MoD security structures also played a role in selecting bidders. In evidence before the Public Accounts Committee, Sir Robert Walmsley, Chief of Defence Procurement from the Ministry of Defence, said, “The conclusion that we came to was that with one non-compliant, publicly- financed bid from GPT, a genuine, absolute, technical, non-compliance would not have delivered the service because they were determined to move it into a packet switch network mode which would not have been supported by our cryptographic equipment.” 100

Another aspect of the security arrangements put in place for the DFT is the scheme operated by the UK Government whereby the personnel, procedures and buildings of private companies can be qualified to hold Government information and materials securely. This comprises a standards document (the Manual of Protective Security) and an organisation which provides advice on its application and audits compliance. BT’s corporate security has been approved on this basis. BT staff and equipment operating on MoD sites are subject to specific MoD security requirements.101

Four DFTS services and three types of communications products were tested rigorously by independent assessors, on behalf of the Communications Electronic Security Group (CESG), part of the Government’s Communications Headquarters (GCHQ), based in Cheltenham. Certificates have been awarded under the UK Information Technology Security Evaluation and Certification (ITSEC) scheme.102

BT and the DCSA developed and provided an Internet Gateway Service (IGS) within the DFTS programme. Generally, because of security restrictions, the MoD had previously been hindered from enjoying the full business benefits of accessing the Internet. All access to Internet sources is now recorded for audit purposes and the inclusion of additional monitoring features, such as e-mail screening for malicious software, further enhances protection.103

98 p. 54, NAO Report. 99 p. 25, NAO Report. Article 223 of the Treaty of Rome, replaced by Article 296 of the European Union Combined Treaties, contains an exclusion from competition rules for members’ defence bodies. 100 Response to Question 7. Minutes of Evidence. Taken before the Public Accounts Committee. Wednesday 5 April 2000. 101 DCSA memo, 20 Dec 2002. 102 “British Armed Forces IT networks overhauled in PFI deal”, BT press release, April 2001. 103 p. 81, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk.

LN1:#20065849 50 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 51 All non-MOD customers who are offered use of the DFTS by BT, have to be approved by MOD/DCSA to the extent that they must satisfy security criteria. The contractual terms of each service include a security Code of Connection. MoD has no objection to any user which can comply with it.104

Although Galileo will have a security structure the parameters of which will be established by the Galileo Security Board/Authority, the EC may wish to ensure that a provision of the concession contract includes something like the MoD’s Manual of Protective Security and its Code of Connection so that third party service providers and any other part of the Galileo infrastructure not under the direct control of the GOC are required to comply with certain security provisions and that there is an audit mechanism to check compliance.

5.3 AGREEMENT BETWEEN THE PUBLIC AND THE PRIVATE ENTITY

5.3.1 AVAILABILITY PAYMENTS AND SHARING OF REVENUES

Essentially, BT is paid for providing service and for the achievement of the milestones. Virtually all milestones defined in the contract have been achieved by the due dates.105 BT is recovering its financial outlay, together with ongoing costs of operation, technology enhancement and the like, mainly through usage-based tariffs.106

During the first three years, as stated above, BT was responsible for operating the existing fixed telecommunications services while preparing its system to take over the service at dates agreed in the contract. Until then, BT received payments for the achievement of defined “milestones” towards migration to the new system.

In addition, BT received an “interim tariff” for delivering the existing point-to-point and circuit switched services, which was higher than the final tariff. This was a result of its taking more risk and responsibility for existing systems prior to the defined migration dates than was set out in the invitation to tender. The interim tariffs were negotiated following BT’s selection as preferred bidder. Following the defined migration dates, the MoD made payments based on the new, lower tariff for these services.

Availability payments are interpreted here as payments for the existence of a facility or capability, which are made irrespective of the Authority’s use of the facility. These are a small proportion (about 10 per cent) of the annual payments to BT for DFTS, and are only made for very specialised telecommunications facilities where the security features represent a high proportion of the capital cost. The main mechanism used to bound BT’s volume risk is definition of a minimum usage threshold for most services, below which the tariffs for that service are subject to change or renegotiation.

Over the 10 years, it is possible that the demand for some or all of the services may fall. If demand falls persistently below these thresholds, BT can treat this as a voluntary termination. BT can then cease delivery of that service, and will receive compensation from the MoD. 107

BT can charge the MoD extra if, as a direct result of the MoD’s technical, security or operational requirements, BT incur additional costs in providing the services by a method

104 e-mail from DCSA, 21 Jan 2003. 105 p. 5, NAO Report. 106 p. 81-82, “Partnership for Defence” by Janet Williams, BT Defence, and Cdr M Dennis-Jones, Deputy TL, Defence Communication Services Agency, Public Service Review, Spring 2001. See www.publicservice.co.uk. 107 p. 51-52, NAO Report.

LN1:#20065849 51 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 52 which is different from its normal method of delivery. Both BT and the MoD agree that this will only take effect if the MoD directs BT to operate in such a way. Normally BT can only recover increases in its operating costs from MoD if these increases are the result of the MoD’s changing its requirements.108

The contract links the MoD’s payments closely to its use of telecommunications services. Thus the majority of payments for these services will depend on the number and size of the sites and the number of individual users taking the services.

The DFTS contract makes provision for sale of DFTS services to third parties, and a significant volume of such sales has taken place, mainly to MoD’s suppliers of information technology (IT) services. Third parties now account for less than 10 per cent of traffic, but their share rising.109 There is no direct revenue sharing, but the increased volume reduces the unit cost of services to MoD.110

Tariffs payable on three of the telecommunications services, the Point-to-Point, Packet Switched, and Call Reception and Delivery services, attract a volume discount. The first two attract discounts of 10 per cent for every 20 per cent increase in the number of users. BT may offer the system to other users, including non-government organisations, which benefits the MoD to the extent that any resulting increase in volume in these services will contribute to the discount received by the MoD. The prices paid per call for the Call Reception and Delivery service decrease if the number of calls exceeds thresholds defined in the contract.

There are no volume discounts for third party use of the other services as the MoD considered that payments for these were already sufficiently sensitive to its own level of use. Nevertheless, the NAO said in its Report that departments should bear in mind the opportunities for such volume discounts when arranging long term service contracts.

The EC and/or JU should take note of the provision in the DFTS contract regarding minimum demand thresholds for certain services as something similar might apply if the Galileo concession fails to achieve revenue expectations on certain services, for example, the public regulated service (PRS). The EC/JU will need to decide to what extent, if any, it will be prepared to fund any shortfall in revenues for particular services.

By the same token, the EC/JU may wish to consider whether certain users (e.g., EU PRS users) could benefit from Galileo revenues exceeding specified expectations.

5.3.2 RESPONSIBILITY FOR SYSTEM EVOLUTION

The PFI has enabled the MoD to procure a managed service providing insulation against technology obsolescence in a sector where it has become difficult for MoD staff to remain competent across the field.111 Recognising that many changes could be expected over the life of the contract, particularly in an industry like telecommunications which is subject to rapid technological advances, MoD required the bidders to incorporate in their proposals the ability to include new services and technology.112

If MoD identifies a new service requirement, it can request a proposal from BT for its delivery. If MoD is not satisfied with BT’s proposals, it can seek the service from another supplier.

108 p. 21, NAO Report. 109 e-mail from DCSA, 21 Jan 03. 110 DCSA memo, 20 Dec 2002. 111 Para 8, Public Accounts Committee. Twenty-Sixth Report. 112 p. 23, NAO Report.

LN1:#20065849 52 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 53 These terms are intended to allow competition and to ensure that any proposal by BT delivers value for money.113

Responsibility for system evolution is seen as a joint responsibility of the DCSA Integrated Project Team and BT. The IPT seeks to identify new telecommunications applications of benefit to the MoD. Although there is no obligation on BT to identify new services, BT is under commercial pressure to reduce service costs and improve existing services. It has an incentive to introduce new services and technology where these would increase use of its services and, consequently, its revenues.

Both parties work closely together in a Business Planning Group, which meets regularly, to identify and consider whether new or improved services are desirable. The group currently delivers about 30 such system evolutions annually.114 The Business Planning Group is expected to ensure that the MoD’s requirements for new technology are met. 115

The Public Accounts Committee found it “strange” that the contract had not built in the need for increasing standards over time. It said that this would have ensured that the MoD's fixed telecommunications services do not fall behind higher levels of technology which the market may provide. MoD acknowledged this point but said the contract provides flexibility to add in new services. The pricing of services could be adjusted to take account of new technology. The provision for transfer payments also encourages technology refreshment. MoD can also hold competitions for new services to ensure it obtains the best value for money. 116

BT told the PAC that it would put in place new assets to provide up-to-date technology where this was required to meet MoD service standards. It would not transfer capital expenditure to MoD but it would work out with MoD what the cost of the service was and would aim to recover it through service charges. 117

The EC/JU should ensure that its contract with the Galileo Operating Company has effective terms so that services are delivered as specified, and that incentives and flexibility are built in to the contract terms to ensure that services do not become expensive or obsolete. Provision could also be made for increasing standards of service and technology over time.

The joint MoD/BT Business Planning Group, meeting regularly, appears to be a useful model for implementation of the Galileo concession. In the Galileo context, such a business planning group could comprise representatives from ESA, the EC, Member States and/or certain user groups. The terms of reference for such a planning group would need to be carefully delineated with respect to the regulatory functions of a separate Galileo regulatory agency. The MoD attributes a significant part of the success so far achieved in the implementation of the DFTS to the harmonious working relationship established between the DCSA and BT. A potentially adversarial relationship between the Galileo regulator and the GOC may have trouble achieving comparable success.

5.3.3 SERVICE GUARANTEES

The DFTS contract contains detailed specifications for each service. (Under the old arrangements, prior to the contract, MoD did not have specified levels of service.118) Where a

113 p. 50-1, NAO Report. 114 DCSA memo, 20 Dec 2002. 115 p. 51, NAO Report. 116 Para 46, Public Accounts Committee. Twenty-Sixth Report. 117 Para 47, Public Accounts Committee. Twenty-Sixth Report. 118 Response to Question 28. Minutes of Evidence. Taken before the Public Accounts Committee. Wednesday 5 April 2000.

LN1:#20065849 53 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 54 service provided by BT is not compliant with the specification, there are provisions for payment to be reduced or terminated.119

If BT fails to provide the levels of reliability of services due under the contract, it may incur service credits, which are a standard form of compensation in telecommunications contracts. Under the service credit regime, if BT’s performance in a particular period has been poor, then a percentage of the payments made for that period is deducted from payments for the following period. BT’s liability to credits is capped at a maximum of between 20 and 50 per cent, depending on the service involved, so that it will still receive some payment in the event of poor performance. Nevertheless, service credits act as an incentive for BT to return a service to full performance as quickly as possible in the event of a failure. 120

If BT fails beyond the 50 per cent maximum of credits payable to the MoD, extreme action could be taken and parts of the contract could be taken away from it. If BT was so bad at performing, the whole contract could be taken away, but this may not be feasible. Termination in breach is an option difficult to execute. There would need to be a migration period to new management arrangements. There would need to be co-operation between BT and a new supplier.121

The NAO identified various concerns about the service credit regime in the DFTS contract:122

• The maximum level of service credits that BT can incur is capped at between 20 to 50 per cent, depending on the service involved. In other Private Finance Initiative projects, deductions of up to 100 per cent can be made if a contractor’s performance is sufficiently poor.

• The levels of service failure allowed before service credits are incurred under the contract are higher than usual under a long term telecommunications contract so the regime is less stringent than industry norms.

• BT’s total liability to the Department in any one year, including service credits payable, is limited to £20 million (approximately 15-20 per cent of the annual contract price) with lower figures for individual telecommunication services.

• The contract states that BT will not be liable for compensation for poor performance by third parties such as sub-contractors, unless BT has full and exclusive responsibility for the delivery of the service. Although the contract separately places responsibility for service delivery with BT, this condition could allow BT to try to avoid compensation, for example, if poor performance arises from a sub-contractor’s decision to which BT is not a party, or if MoD influences the method of service delivery. This was a point of concern as much of the contract is sub-contracted by BT.

• Not all services provided are subject to service credits. Performance is monitored quarterly rather than monthly as is common with other contracts, and the same level of service credit is levied on any site regardless of its size.123

The MoD told the PAC that BT would have demanded a higher price if its whole fee had been at risk and, even with such an arrangement, the MoD did not expect BT to perform so badly that it would have to deduct the whole fee. As a result, the MoD had not seen the point in

119 DCSA memo, 20 Dec 2002. 120 p. 48, NAO Report. 121 Question 74 and response. Minutes of Evidence. Taken before the Public Accounts Committee. Wednesday 5 April 2000. 122 p. 48, NAO Report. 123 p. 49, NAO Report.

LN1:#20065849 54 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 55 trying to negotiate this condition. Neither did it expect to have to threaten BT with terminating the contract. BT said that its brand image and reputation would suffer if it failed to perform to the MoD's satisfaction. This was an incentive for BT to perform well. BT also noted that, in addition to the service credit provisions, the contract had an escalation process which allowed the MoD to come in at a more senior level if it believed BT was not actually responding in the way it should. BT said that, in its opinion, taking the contract as a whole, some of the performance terms were more stringent than other PFI contracts. 124

MoD accepted that compensation would not be payable by BT if, in exceptional circumstances, MoD directed BT to use another service delivery method from that normally used by BT and that other service delivery subsequently failed to perform to contractual requirements. Otherwise BT would be liable to pay compensation for poor performance by its sub-contractors.125 BT assured the PAC that it would be liable to make compensation payments if its sub-contractors failed to perform.

BT could make additional charges if it had to change its method of service delivery from that normally used. The MoD said this was fair as it meant that BT could recover additional costs in the unlikely event that the MoD directed it to use an unusual method of service delivery. The usual PFI approach was to allow the contractor to decide how to meet MoD requirements, and the MoD would follow this approach unless there were unusual circumstances. 126

The EC/JU will need to decide whether a service credit regime might be appropriate in the Galileo case and, if so, what level of service credit – ranging up to 100 per cent – might be appropriate and what level of service failure should be allowed before service credits are incurred. The EC/ESA will need to put in place some mechanism for monitoring the GOC’s and the Galileo infrastructure performance and the frequency with which performance will be monitored, i.e., quarterly, monthly or more often. It will also need to decide who should “carry the can” with regard to the performance of sub-contractors, especially if the GSB, EC/JU or a Galileo regulator were to direct the GOC to provide service in some unusual way.

5.3.4 PERFORMANCE MEASUREMENTS

BT carries out most service performance measurements under the reporting requirements of the contract. Confidence in their accuracy derives from BT’s ISO 9000 qualification. The MoD also has its own performance measurement capabilities, which have been deployed occasionally.127 The MoD has direct access to BT’s management information system and the performance data contained on this, and meet BT regularly at working and senior management level to receive and discuss regular performance reports.

5.3.5 THIRD PARTY LIABILITIES

Potential liabilities (i.e., risks) from supply of DFTS services to third parties are managed through and limited by a contract which they sign. This ensures that service delivery risks are carried by BT.128 The resulting risks are consequently relatively small.129

124 Para 35, Public Accounts Committee. Twenty-Sixth Report. 125 In evidence before the Public Accounts Committee, the BT representative explicitly said BT would be responsible for the performance of its subcontractors. See the response to Question 73. Minutes of Evidence. 126 Para 36, Public Accounts Committee. Twenty-Sixth Report. 127 DCSA memo, 20 Dec 2002. 128 DCSA memo, 20 Dec 2002. 129 e-mail from DCSA, 21 Jan 2003.

LN1:#20065849 55 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 56 5.3.6 RISK MANAGEMENT AND RISK SHARING

One of the keys to getting good value for money from PFI is to identify all of the risks associated with a project and then allocate these risks to the party best able to manage them. Only by identifying and pricing risks can the public sector manage risks efficiently, concentrating on those that are likely to have the greatest impacts. As PFI has matured, the public sector has learned that best value will be obtained by optimal risk allocation not maximum risk transfer to the private sector.130

The original DFTS contract, and the many changes to it since 1997, were drafted with considerable attention to the allocation of risk. UK Government accounting rules also require careful scrutiny of risk allocation in a service provision contract in order to determine the balance sheet treatment of assets. In general, technical and performance risks are accepted by BT, while MoD retains certain regulatory, security and volume risks, but the allocation is performed as precisely as possible on a service by service basis.131 The main retained regulatory risk is that of security. The UK government sets out rules and standards for handling of confidential data, as previously referenced in section 5.2.6. Those rules change from time to time, e.g., to reflect increased terrorist threats. The costs of such change to DFTS fall to MoD since the contract is against a given baseline set of rules.132

BT is responsible for maintenance risks and for replacing obsolescent equipment. The NAO Report said the MoD should have quantified this risk transfer to demonstrate whether the price paid was value for money.133

Appendix 3 of the NAO Report sets out 24 major risks and to whom they are allocated (i.e., MoD, BT or shared).134 The categories of risk are as follows:

• design and implementation;

• operation;

• availability;

• volume;

• technology/obsolescence;

• residual value;

• legislation/regulation;

• employment;

• finance; and

• disposal.

130 p. 152, “Reward without risk? Innovation in PFI”, by Matthew Tulley, Senior Auditor National Audit Office, Public Service Review, 30 Jan 2002. 131 DCSA memo, 20 Dec 2002. 132 E-mail from DCSA, 25 Feb 2003. 133 p. 4, NAO Report. 134 See http://www.nao.gov.uk/publications/nao_reports/9900328.pdf.

LN1:#20065849 56 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 57 5.3.6.1 How much risk to transfer

The NAO said that under the DFTS PFI, MoD retained more risks than in other privately financed contracts. MoD may have missed opportunities for better value for money by not seeking greater transfer of these risks where BT is best able to manage them. The MoD believes that all risks considered appropriate for transfer at the time it was developing this project have been transferred to the contractor, and that transferring further risks would have been at a price which would have reduced value for money.135

The Public Accounts Committee also questioned the extent of the risks transferred and whether the restrictions on risk transfer were attributable to the relatively low level of external legal advice which the MOD used during the procurement. 136

For its part, BT has commented that “Both PFI and PPP are rapidly-evolving art-forms and BT is playing its part in that development. The commercial deals that enable these projects are a function of current knowledge, the procuring department's aims and the way in which the deal is financed.

"The risks to be apportioned in a project will change from deal to deal. At the same time, increasing sophistication within the market, coupled with the experience gained from signed projects, means that the risks which both the public and private sector are able to assume are also changing. There is no absolute template that can be applied; even on the same project different bidding consortia will have priced for different risks - and they will assume them to different degrees.”137

5.3.6.2 Risks from the scope of the contract

MoD considered that the project involved considerable risk because it was large and novel, and that expanding the project to include mobile and/or satellite communications would have added further to its complexity. It would have prolonged the competition and led to delays in the achievement of identified savings they expected to secure through rationalising the delivery of fixed telecommunications services. BT, the winning bidder, supports this view.138 See section 5.4.1.3 for more discussion of this point.

5.3.6.3 Risks from long contracts

Long-term contracts encourage suppliers to undertake costly investment projects, but also create a long-term monopoly and scope for ‘hold up’. The problem of specifying completely such long-term contracts means that both principal and agent might have to rely on partnership, trust and reputation. Reliance on these intangible elements makes it more difficult to monitor and legally enforce contracts.139

Long contract periods for telecommunications and information technology contracts carry risks because these markets are subject to rapid technological changes and purchasers may want new forms of service delivery. A long term contract with one supplier therefore presents the risk that services could become obsolete. It can also limit scope for achieving value for money for new requirements if it means their provision will not be subjected to a competition. In addition, competition in the telecommunications industry is increasing and is expected to increase further in coming years, so there is also a risk that prices in a long term contract may not fall in line with market pressures.

135 p. 20, NAO Report. 136 Para 31, Public Accounts Committee. Twenty-Sixth Report. 137 e-mail from Janet Williams, BT, 24 Jan 2003. 138 p. 2, NAO Report. 139 p. 15-6, Parker & Hartley.

LN1:#20065849 57 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 58 A 10-year contract period entails a number of risks for the MoD arising from the rate of change and increasing competition in the telecommunications industry. How effectively the contract deals with changes is therefore an important element in ensuring value for money.140

The effectiveness with which changes are dealt with will be an important element in judging whether the contract period is appropriate. Under a long term contract, such as that envisaged for Galileo – 20 years, twice as long as that for the DFTS, has been mentioned – it is, therefore, important that:

• there is sufficient flexibility to handle change;

• there are mechanisms to ensure prices are competitive with the market; and

• the terms allow a new competition for the contract to be held at the end of the period.141

5.3.6.4 Risk of pricing changes

There is a risk that, over the life of the contract, BT may seek to change the pricing of services or the way it delivers services in ways which will improve its returns from the contract. This could impact adversely on the MoD's achievement of value for money. The contract does contains conditions under which BT's prices must, in part, take account of other suppliers' prices and the MoD can challenge the value for money of BT's prices. But the challenge conditions are vaguely worded so the MoD may be exposed.

5.3.6.5 Risk to future competition

The Public Accounts Committee said it was “concerned that it may be difficult for other firms to compete effectively with BT for a new contract as BT will have run the new system for 10 years. This would allow BT to improve its returns in a new contract. And, although we note the Department's assertion that it could refuse to allow BT to enter into a future competition, other bidders will have to pay BT if they wish to make use of BT's assets.” 142

Despite the requirements to make information available for a further competition, BT’s experience of operating the MoD’s fixed telecommunications will mean that it will be the only supplier with full knowledge of the MoD’s service requirements. This could place it at an advantage in the future competition, and other telecommunications suppliers have told the National Audit Office that they are unlikely to bid against BT as they would expect BT to retain the contract.143

The MoD said it believed a future competition would be effective. If BT had not performed satisfactorily, the MoD would not invite them to bid for the new contract. Also, the new contract would be less complex than the current one as BT had already rationalised the MoD's previous four networks and 46 services to one network and six services, managed by one organisation. A new supplier would just have to operate the new system.144 Also, the scope of the contract may change, which may encourage other suppliers to bid.145

The MoD also expected that there would be greater competition in the UK telecommunications market in 10 years' time, and that BT would be less dominant at the end

140 pp. 2-3, NAO Report. 141 pp. 21-3, NAO Report. 142 Para 26-7, Public Accounts Committee. Twenty-Sixth Report. 143 p. 53, NAO Report. 144 Para 20, Public Accounts Committee. Twenty-Sixth Report. 145 p. 6, NAO Report.

LN1:#20065849 58 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 59 of that period. BT said it was likely to be involved in the new contract whether or not it won the competition, due to its unique network coverage of the United Kingdom. 146

The risk to future competition is no less important to Galileo than to the DFTS. The EC/JU must negotiate a contract with the GOC which contains provisions which will ensure genuine competition for a new concession period. There is an obligation on BT to provide certain information towards the end of the DFTS contract term. The EC /JU should insert similar provisions into the Galileo concession contract.

5.3.6.6 Risks associated with transfer payments

The Public Accounts Committee said it was concerned about the possible effect of transfer payments on value for money in privately financed contracts.147 The transfer payment arrangements have potential drawbacks. First, if the transfer payment is set too high, it may deter suppliers from bidding for the next contract. Alternatively, if they do bid, their prices, after taking account of the transfer payment, may not represent value for money or they may not be able to afford to make further improvements to the systems. Second, there is a risk that BT may be paid twice for the assets if BT receives the transfer payment but has already recovered part or all of the cost of the assets in its original pricing of the contract or in subsequent price variations.

As BT will have a strong chance of winning future competitions but cannot be sure of this, it is to be expected that it will seek to recover its investment in assets during the existing contract period. This is evidenced by the fact that prices charged over 10 years are less than over five years, in part because BT can recover its investment over a longer period. This means the transfer payment arrangement is unlikely in itself to incentivise BT to invest in new technology but could result in BT’s being paid for transferred assets both through annual service payments and through transfer payments if MoD chooses to award the next contract to another supplier.

An incoming contractor is not bound to use BT’s assets. Where BT’s assets are used by the new contractor, the agreed formula for calculating the transfer payment will at least place a limit on the amount that BT can receive for their assets, based on a percentage of the annual contract cost. In addition, BT will only receive this amount from an incoming contractor whose bid, after taking account of any transfer payments for BT assets, has been judged by MoD to be superior to BT’s bid in the future competition.148

The transfer payments were designed to ensure that an incoming contractor could obtain BT's assets as necessary and at a fair price. It was thought that this would provide an incentive for BT to ensure its systems were maintained properly to allow continued service delivery. This was regarded as vital to ensuring that the MoD's telecommunications services were not disrupted if the MoD had to change contractor at the end of the period. The MoD informed the Public Accounts Committee that the transfer payments would be based on expenditure in 2006-07 and could, therefore, be more than the estimate of £43 million based on expenditure in 1999-2000. On the issue of whether BT could be paid twice for assets transferred, the MoD said that during the contract period BT would not automatically recover the cost of investing in assets. Service prices were not determined by what BT paid for its equipment, but by agreed prices, which were determined, in part, by the price of telecommunication services in the market. 149

146 Para 21, Public Accounts Committee. Twenty-Sixth Report. 147 Para 5(ix), Public Accounts Committee. Twenty-Sixth Report. 148 p. 54-5, NAO Report. 149 Para 18, Public Accounts Committee. Twenty-Sixth Report.

LN1:#20065849 59 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 60 Like MoD, the EC/JU will need to construct very carefully the transfer payment arrangements in the Galileo concession contract, with particular attention to ensuring that the first concessionaire is not overpaid for assets the costs of which it has already recovered during the term of the concession. Also, the transfer payments should not be so high that they act as a disincentive to other prospective bidders for the next concession period and raise the cost of services to Galileo users.

5.3.7 RELATIONSHIP BETWEEN THE PRIVATE ENTITY AND THE COUNTERPARTY TO THE CONCESSION

A close working relationship between the IPT and BT, to ensure day-to-day issues are resolved rapidly and efficiently, has been essential to the success of DFTS. The IPT and the core BT team operate from the same office and have a common office IT system, although both parties retain separate access to their corporate IT systems. This does not prevent vigorous scrutiny by the IPT of BT’s performance and attention to value for money in contract changes.150

5.3.7.1 Benchmarking

Shortly after the MoD and BT signed the contract in July 1997, the MoD retained Ovum, the UK consultancy, to confirm that prices in the contract were reasonable and to benchmark the agreed prices with industry comparators on a quarterly basis as a way of ensuring prices continue to deliver value for money and to provide evidence, if necessary, in a value for money challenge. Ovum concluded that the prices were generally favourable, bearing in mind the MoD’s special security requirements, which meant that each price would contain a premium to provide these requirements. This information has helped the MoD to monitor the reasonableness of BT’s prices.151

Subsequently, the NAO commissioned Mason Communications to compare the service prices in the contract with other prices for telecommunications services for large organisations. Taking into account the MoD’s security and resilience requirements, contract prices contain a premium for the delivery of these requirements so comparisons with other organisations are not straightforward. Nevertheless, Mason found that most of the monthly prices in the contract compared favourably with their comparators.152

BT’s prices are adjusted annually153 against a basket of telecommunications prices according to a different Variation of Prices formula for each service. The formula for each service contains combinations of labour, materials, transport and telecommunications prices which reflect the underlying cost base in providing that service. The weight attached to the different elements varies in each formula in recognition of the different elements used to provide each service. If necessary or appropriate, both parties can agree changes to the composition of the baskets, to include new services available in the market or to take account of price changes in the market.154 In other words, BT are supposed to reflect other suppliers’ prices in the annual price variations.

The NAO Report said that departments should consider whether benchmarking prices before contract signature can help their position in negotiations. In a field like telecommunications,

150 DCSA memo, 20 Dec 2002. 151 p. 38, NAO Report. 152 p. 39, NAO Report. 153 p. 5, NAO Report. The Report observed that prices for telecommunications services, which are expected to fall, are adjusted annually, whereas prices for other elements, which are expected to rise, are adjusted quarterly. 154 Para 14, Public Accounts Committee. Twenty-Sixth Report.

LN1:#20065849 60 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 61 where prices change frequently, they should also regularly benchmark contract prices against prices charged by other suppliers for comparable services. This is common industry practice to assess the value for money of services provided, and is being followed by the MoD in this contract. Benchmarking also assists discussions about prices, where the contract allows prices to be adjusted if they are uncompetitive.155

Including benchmarking formulae in the Galileo concession contract would seem to make sense, except that it will be rather more difficult to compare Galileo prices against other suppliers in the industry since Galileo’s only serious competitor will be GPS, which does not offer value-added services, as Galileo intends to do. Nevertheless, it may be possible to develop benchmarking formulae based on third-party GPS service providers.

The EC/JU should also take note of the NAO Report’s point about benchmarking prices before as well as after contract signature.

5.3.7.2 Value for money challenges

The contract gives the MoD the right to make three value for money challenges during the contract period on each of the six services if it feels that BT is no longer providing value for money, despite the Variation of Prices formula. This gives the MoD a maximum total of 18 possible challenges throughout the 10 years of the contract. A value for money challenge would involve benchmarking BT’s prices against market comparators in order to demonstrate to BT that it was not providing value for money. The MoD would then have to obtain BT’s agreement to reduce its prices for that service, or otherwise improve the value for money of the service. If BT fails to reduce its prices, the MoD could seek the service from another supplier. 156

The NAO legal consultants considered that the value for money challenge provisions were not drafted clearly enough to be relied upon by the MoD in the event of a dispute with BT. The price challenge mechanism can only be used in exceptional but undefined circumstances. (Other Private Finance Initiative contracts set out that prices should be fully benchmarked at periodic intervals against other suppliers’ prices and do not restrict this to exceptional circumstances.157) The condition that the circumstances should be exceptional may allow BT to resist the use of the value for money challenge mechanism. Although the challenge is to allow a value for money review to be undertaken, the absence of guidance on how value for money should be measured (for example, by reference to similar services provided by other suppliers) could result in disputes if the parties fail to agree on how the value for money review is to be carried out.

The MoD believed that defining specific conditions would have been too restrictive, would have resulted in legal difficulties in the event of a challenge and would reduce its chance of success. The MoD felt that where there are tight descriptions, they become prescriptive and easier to avoid. The MoD felt it would have been unable to predict the exceptional circumstances in advance.158 Therefore, drafting a contract which lays down all the exceptional circumstances would not be beneficial for the MoD. It considered that a generalised arrangement gave it freedom to specify the circumstances for a challenge as they arose. The MoD would decide whether an exceptional circumstance had arisen. (In evidence before the Public Accounts Committee, Sir Robert Walmsley said that what would be exceptional would be that BT, as the nation's premier provider of telecommunications, were

155 p. 8, NAO Report. 156 Para 15, Public Accounts Committee. Twenty-Sixth Report. 157 p. 21, NAO Report. 158 Another reason for the lack of specificity was the range and diversity of DFTS services, according to an e- mail from DCSA 21 Jan 2003.

LN1:#20065849 61 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 62 failing to demonstrate value for money to the MoD.159) MoD would then have to persuade BT that the situation was exceptional but the MoD does not anticipate any difficulty in doing this because it would have evidence from its independent benchmarking consultants. 160

There are also practical disincentives to mounting such a challenge, as it would take time to effect and the MoD would need to be very certain of its case before attempting this. BT will have taken account of these challenge provisions when pricing the contract. The impact of the challenge provisions in the contract will only be good value for money if BT has a genuine concern that a challenge may be made.161

As of February 2003, only one VFM challenge has taken place. It resulted in a 16 per cent reduction in the cost of the service concerned.162 Consequently, the IPT view is that the NAO fears have been largely put to rest by the successful conclusion of the VFM challenge (which took place over the last 18 months and was only finally closed in all contractual aspects in mid-February 2003). This was for a major service currently amounting to about 15% of the contract annual value, and not only cut the cost by 16% but also introduced service quality improvements. Thus, it appears that the contractual wording has not been an impediment to achieving the desired objective.163

Containing value for money challenge provisions in the Galileo concession may also make sense, but the determination to include such provisions will need to made with a view to the powers of the Galileo Regulatory Agency. If the Galileo regulator will be vested with powers for capping service charges similar to those of Oftel, for example, the VFM challenges may be unnecessary.

If a provision re VFM challenge were included in the Galileo concession contract, and given the fact that Galileo will offer a more bounded range of services than the DFTS, it should be easier to establish a formalised mechanism for determining VFM and hence the criteria for a challenge.

5.3.8 REMEDIES IN THE CASE OF DEFAULT BY THE PRIVATE ENTITY

There are several remedies built into the DFTS contract, including:

• reductions in service charges for minor deficiencies in service performance (service credits);

• price variations;

• escalation procedures, whereby issues are handled at an organisational level commensurate with their importance;164

• value for money challenges. In the event of a MoD challenge where BT would say it is not exceptional, then independent arbitration would have that remedy;

• dispute procedures; and

159 See Questions 29-31 and the responses. Minutes of Evidence. Taken before the Public Accounts Committee. Wednesday 5 April 2000. 160 Para 16, Public Accounts Committee. Twenty-Sixth Report. 161 pp. 42-7, NAO Report. 162 E-mail from DCSA 21 Jan 2003. 163 E-mail from Peter Boait (DCSA), 21 Feb 2003. 164 DCSA memo, 20 Dec 2002.

LN1:#20065849 62 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 63 • a provision for MoD to procure services from another supplier in the event of gross failure to deliver.

Value for money is based on price variation and benchmarking. It is testable over time. MoD's independent advisors will declare what value for money is. BT has said that it would accept that. 165

If BT’s performance is persistently poor or falls below the standards at which the maximum service credits are payable, the MoD may deem it to be in breach of contract. In this case, the MoD can suspend payments until their performance improves. If there is no improvement, the MoD can terminate the relevant part of the contract and replace BT with another supplier.

The MoD can only terminate the whole contract if a breach materially deprives the MoD of the benefit of the contract. The expression “benefit of the contract” is not defined in the contract, as it is standard practice to avoid definitions which are too restrictive and therefore more likely to lead to disputes. The MoD considers that its ability to terminate parts of the contract provide it with sufficient protection in the event of breaches as MoD believes that it would not be practical to terminate the whole contract.166

With a contract of this size and importance, the bigger risk to BT is not the service credits, it is that poor performance affects brand reputation and all the other contracts that BT would hope to win in the UK. 167

The EC/JU will also need to build in remedies in the event of a failure by the GOC to comply with the terms of its concession contract. Like those in the DFTS contract, the remedies will need to vary in proportion to the seriousness of the failure to comply. However, as BT has said, the damage to reputation is more effective than service credits.

5.3.9 DURATION OF THE CONCESSION AND BREAK MECHANISMS

The MoD initially invited tenders for a five-year period to cover implementation of the DFTS, after which the MoD would operate and maintain the services. Bidders were, however, free to propose additional contract periods of up to five years, during which they would take some responsibility for operation and maintenance of the system, if they could demonstrate this would offer value for money. MoD increased the contract period as bidders proposed greater savings over 10 years.

GPT and Nortel bid on the basis of a five-year period, but Racal stated it would require a minimum period of 10 years. BT bid on the basis of a five-year implementation contract, but also showed that it could produce greater savings if it were allowed a longer contract period. BT and Racal’s preferred solutions involved managing the MoD’s fixed telecommunications for up to five years after implementing the new system.

In December 1995, after considering other contract periods, the MoD invited BT and Racal to submit further bids, their Best and Final Offers, for a 10-year contract period. MoD assessments of the earlier bids showed that 10 years offered the greatest savings, allowed more scope for innovation than a shorter period, would allow annual charges to the MoD to be reduced as bidders would have longer to recover the costs of their investment, and would enable the MoD to retain some flexibility that would be lost by being locked into a longer term contract. The length also reflected the fact that the project is complex and required a three-

165 Response to Questions 133-34. Minutes of Evidence. Taken before the Public Accounts Committee. Wednesday 5 April 2000. 166 p. 50, NAO Report. 167 Response to Question 130. Minutes of Evidence. Taken before the Public Accounts Committee. Wednesday 5 April 2000.

LN1:#20065849 63 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 64 year implementation period before the new system was fully operational.168 The longer period may also allow MoD to benefit from a more developed working relationship with its contractor.

There are provisions for continuation of service beyond July 2007, to facilitate migration to another service provider following recompetition. There are break mechanisms to allow some or all services to be terminated early either through failure of BT to deliver or if MoD no longer has a requirement. Cessation of a major service, as a result of technical obsolescence, is currently in progress under a negotiated rundown programme.169

Although contracts for many privately financed projects are much longer than 10 years, the length of PFI contracts for information technology and telecommunications services has generally been between five and 10 years due to rapid technological changes in these sectors, with the current trend being towards 10-year contracts.

The EC/JU should consider carefully the appropriate duration of the concession in light of pros and cons associated with durations of 10 or 15 or 20 years. A duration of 20 years seems to be favoured at the moment, but such a long term puts at greater risk the prospect of renewed, genuine competition at the end of the term.

5.4 LESSONS LEARNED

As the DFTS was one of the first and biggest MoD PFIs, it has yielded many valuable lessons for other PFIs. The following are among those identified by the MoD, the NAO and the PAC.

Ministry of Defence

The MoD offers the following lessons learned on its web site:

• Always timetable a reflection session to follow a negotiation session ensuring full capture of issues.

• Negotiations are physically and emotionally tiring.

• Incorporate influential senior members of staff onto a steering committee. Visibility and understanding of the issues on their part will ease downstream approval.

• Never underestimate the need to keep everyone informed and happy.

• The project will devour resources (people, time).

• A cost model, that supports sensitivity analysis, is very useful to aid the tender assessment process.

• Good quality legal support is essential.

In correspondence with the author, DCSA mentioned some additional practical lessons:

• The importance of a close working relationship, which is essential to ensure a common vision and interpretation is derived from what is inevitably a very complex contract.

168 pp. 2-3, NAO Report. 169 DCSA memo, 20 Dec 2002.

LN1:#20065849 64 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 65 • Joint organisational structures are needed to manage and prioritise the “system evolution” as described in section 5.3.2. The number of DFTS contract changes for service enhancements and new services has greatly exceeded expectations.

• It would have been preferable to agree at the start of contract the level of financial transparency to be expected from BT. Greater visibility of BT’s costs and profitability would help in the creation of value for money and business cases to support service enhancements and new services.170 Financial transparency is particularly important where there are limited market comparators for a service and hence benchmarking is problematic. In such circumstances, it is vital for the public authority (or Galileo regulator) to have confidence that the concessionaire’s cost structure and profit level are reasonable. National Audit Office

The National Audit Office Report also cites a number of “lessons learned” (conclusions and recommendations), among which are the following:

5.4.1.1 Use of the EU negotiated procedure

There was an awareness within the MoD and in the private finance market that the European Union negotiated procedure was appropriate for privately financed deals, although the MoD’s project team said they were not advised to follow this procedure. Better external advice may have led to the MoD following the negotiated procedure.171

The MoD may have been able to maintain competition and secure price reductions in a shorter time and at a lower cost to bidders by allowing full negotiations and discussions with bidders, as provided for under the European Union negotiated procedure. This procedure allows earlier detailed negotiation with the bidders and greater scope for discussions of innovations, so is better suited to complex privately financed procurement than the procedure adopted by the MoD for this procurement. The MoD noted that the European Union Public Procurement regulations state that this procedure is to be used “exceptionally where the nature of the services to be provided; or the risks pertaining thereto are such as not to permit prior overall pricing”.172 However, the MoD acknowledge the utility of the negotiated procedure, and recommend it in their current guidance on Private Finance Initiative procurement.173

During the procurement process, the MoD’s calculations showed many changes in the savings that the bids would deliver, compared with continuing the existing systems. The changes arose from the MoD’s changing its estimates of the costs of continuing the existing systems, amending the scope of the project, and other pricing changes by the bidders. These various changes made it difficult for the MoD to monitor the comparative value of the bids they received at different stages of the procurement. 174

The MoD was not in a position to demonstrate that the BT bid was better value for money than might have been obtained under traditional procurement, as the MoD did not know the cost of a fully compliant publicly funded alternative.175

170 DCSA memo, 20 Dec 2002. 171 pp. 3-4, NAO Report. 172 European Union Public Services Contracts Regulations 1993, Regulation 10(2)(b). 173 p. 26, NAO Report. 174 p. 32, NAO Report. 175 p. 33, NAO Report.

LN1:#20065849 65 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 66 5.4.1.2 Bringing in external advisors at the planning stage

The MoD did not appoint their own legal advisor, Burges Salmon, until after BT had been selected as preferred bidder. The MoD did not seek competitive tenders from other firms and only sought input from Burges Salmon on limited areas of the contract and negotiations. In other areas, the MoD negotiated the contract based on the terms initially proposed by BT without Burges Salmon. The NAO said that this contributed to some aspects of the contract being more favourable to BT than the NAO would have expected.176

Even where departments have in-house staff with expertise in traditional forms of procurement, they should still consider at the outset what additional skills external advisors can contribute to a privately financed project. It can be a false economy not to make use of external advice. Advisors should be appointed through competition.177

The MoD would have been in a stronger position to negotiate a contract which better protected its interests if it had:

• brought its legal team together at the planning stage;

• identified firms with the most relevant experience, and sought competitive tenders from those firms; and

• asked their external legal advisor to:

o assist MoD staff with advice on the most appropriate procurement procedures for a project under the Private Finance Initiative;

o comment on the proposed contract period;

o comment on the legal aspects of alternative bids before the preferred bidder was selected; and

o review all contract documentation before contract letting.178

The Public Accounts Committee said it was “also very surprised that the Department allowed BT to put forward its own proposed contract as the basis for the contract negotiations. Although the Department subsequently sought to negotiate many of the terms proposed by BT, we feel that this approach will inevitably have given the upper hand to BT in the contract negotiations. We consider this is likely to have contributed to the result that a number of the important contract terms are more favourable to BT than those adopted in other PFI contracts”. 179

BT said that, although it had put forward headings for the contract and proposed contract terms, the MoD had negotiated changes to nearly every line of the draft contract and the MoD had always been tough but fair in negotiations whether or not legal advisers had been involved. 180

Nevertheless, the NAO says departments should ask contractors to price their bids on a set of contract terms developed by the departments and their advisors, making use of the Treasury’s guidance on contract terms.

176 p. 6, NAO Report. 177 p. 7, NAO Report. 178 p. 58-9, NAO Report. 179 Para 5(xi), Public Accounts Committee. Twenty-Sixth Report. 180 Para 37, Public Accounts Committee. Twenty-Sixth Report.

LN1:#20065849 66 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 67 5.4.1.3 Scope of the contract

The scope of the project may not have maximised value for money. There are interrelationships between the MoD’s various communication systems and rapidly changing technology requires fast and frequent reassessment of the most effective form of service delivery. But, having decided to procure a new fixed telecommunications system, the MoD did not assess the potential advantages and disadvantages of expanding or reducing the scope of the project. A strategic review of the project scope would have helped to balance delays in achieving savings against both the risks and possible further savings from a project with a different scope.

Where there are interrelationships and potential synergies between different services, the NAO believes that departments should appraise their strategy for delivering all such services before developing a long-term project for any of them. They should also be open to suggestions from bidders as to how to draw the boundaries of a project to maximise value for money. After letting a contract, a department should reassess the scope of the project at periodic intervals during the contract period and prior to any further competition.181

Departments should reserve the right to modify the bidding process in any way which seems likely to improve value for money. In this project, for example, the MoD obtained significant price reductions by asking the final bidders to reassess their bids before selecting the preferred contractor. Departments should be careful, nonetheless, to avoid making a general practice of asking for further rounds of bids as bidders would be likely to anticipate this and take it into account when making their opening bids. They should also try to avoid increasing bidding time and costs unnecessarily.182

Public Accounts Committee

The Public Accounts Committee identified a number of key points. Among those not already referenced above from the NAO Report are the following:

The MoD appears to have achieved a good price but will need to manage the contract effectively to prevent BT clawing back value. 183

There is a risk, however, that BT's prices may fall out of line with the generally decreasing prices in the telecommunications market. The MoD's ability to realise its projected savings from this contract depends, however, on using the contractual arrangements to maintain value for money.

Departments must be in an informed position when they approach the development of a PFI contract and the subsequent negotiations.

Competitive tension is key to obtaining value for money in PFI procurement. 184

181 p. 15, NAO Report. 182 p. 8, NAO Report. 183 Para 4, Public Accounts Committee. Twenty-Sixth Report. 184 Para 5, Public Accounts Committee. Twenty-Sixth Report.

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6 SKYNET 5

6.1 BACKGROUND

Skynet 5 will provide the next generation of satellite communications services for the UK military. Two satellites are currently expected to be launched in 2006 and 2007, with full operational capability of Skynet 5 in 2008.185

The satellites will replace the existing Skynet 4 constellation at the end of its predicted life. The programme includes ground connectivity and management facilities and the provision of terminals for both fixed and mobile users in the land and sea environments.186 Initially, the Skynet 5 procurement was for replacement of the space segment and the associated ground and management segments. During bid evaluation, however, bidders were asked to propose extensions to the procurement to include provision of mobile and transportable ground terminals, maritime terminals and modems. The final contract is expected to include these additional items.187

Subject to successful negotiation, MoD expects to place a private finance initiative contract in early 2003.188 With a value of some £2 billion,189 the PFI contract will be the biggest of its kind.190 It will also be the first time that such an approach has been undertaken for providing military satellite communication services.191

6.1.1 APPROACH IN THE SELECTION OF THE PRIVATE SERVICE PROVIDER

The Skynet 5 Assessment Phase began in 1993. MoD explored a range of possible solutions to meet its needs. Three approaches were taken forward. One was a collaborative programme with France and Germany (TRIMILSATCOM); second was conventional asset procurement and third was a Private Finance Initiative (PFI) solution. The United Kingdom, France and Germany signed the TRIMILSATCOM Memorandum of Understanding in December 1997 following which two tri-national consortia, led by Alcatel and Matra-Marconi Space, submitted bids for Project Definition work. In parallel, the United Kingdom sought and received Project Definition bids for a national programme from Matra-Marconi Space and from , teamed with Lockheed Martin. Evaluation of the proposals put forward demonstrated that TRIMILSATCOM would be unable to meet the UK requirements in a timely and affordable way, whereas a PFI offered the potential to do so. The MoD therefore decided in August 1998 not to proceed with TRIMILSATCOM.192

185 The actual launch dates are a matter for the service provider to determine to ensure continuity of service in the transition from Skynet 4 to Skynet 5. E-mail from Defence Procurement Agency, Satellite Communications Integrated Project Team (DPA SAT IPT), 21 Jan 2003. 186 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. 187 www.mod.uk/dpa/projects/skynet5.htm 188 In February 2002, the MoD web site said it expected contract award by August 2002, with Skynet 5 services to begin 2005. However, as of end 2002, there were still several issues to overcome to reach closure. 189 BT press release, April 2001. 190 Statement by Dr Moonie, Secretary of State for Defence, Hansard: Columns 1137-8W. 26 Feb 2002. 191 www.mod.uk/dpa/projects/skynet5.htm 192 “UK Plans Own Defense Satellite Program”, Space Daily, 31 August 1998.

LN1:#20065849 68 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 69 In 1996, MoD used external contractors, including PA and KPMG, to study the feasibility of a PFI solution for the Skynet 5 programme.193

MoD policy states that “….for all projects, MoD will only consider using its own capital funding resources if PFI has been demonstrated to be unworkable, inappropriate or uneconomic.” MoD has a PFI feasibility checklist which is structured around the three high level criteria as being the keys to selecting projects with PFI potential; that is, those that are (a) appropriate, (b) workable, (c) economic. The Private Finance Group (PFG) in the MoD’s Defence Procurement Agency (DPA) has the responsibility to review all equipment project procurement strategies to ensure that PFI is addressed consistently and fairly for each project. The PFG encourages the consideration of a large number of factors that will determine the suitability of PFI for any given application. The high level feasibility criteria are concerned with:

• achieving value for money;

• defining and delivering a workable service; and

• constructing a reasonable deal for the private sector and investors.

The full list of factors within each of these criteria are documented in the DPA PFG’s PFI Feasibility Checklist.194 See Annex 1.

MoD also compared the PFI solution against a public sector comparator.195 PFI procurement is expected to show a saving against the public sector comparator, as well as offering possible non-monetary value (such as schedule advantage).196 If PFI was used simply as a means of delivering exactly the same solution as would be procured conventionally, it would almost certainly be more expensive due to the higher cost of investment capital in the private sector. In order to deliver better value for money (VFM), PFI has to achieve reductions in total project costs. This is usually achieved through one of the following:

• cost savings through:

o innovation,

o more efficient procurement and operation,

o better management of whole life maintenance and obsolescence, or

o more cost effective private sector risk management

193 http://www.paconsulting.com/government/gps_ourwork_sourcing.html. Among other external contractors involved in Skynet 5 prior to the announcement of the preferred bidder was ESYS which developed “a requirements capture methodology for Skynet 5”. See www.space- technology.com/contractors/project/esys. 194 www.ams.mod.uk/ams/content/docs/toolkit/ams/links/pfg_web/library/dpapfu/gnotes/feas.htm. See also Annex 1 of this report which provides extracts from the checklist. 195 The Defence Evaluation & Research Agency, Space Dept (now QinetiQ) developed a simulation-based method for analysing payload designs based on requirements for communication services, as expressed by users. This method is implemented in a computer model called the Satellite Communication System Analysis Package (SCSAP), which helped to size the ‘public sector comparator’ for Skynet 5. See p. 1, Inglis and Vinnicombe. 196 The key value for money test requires that the net present value of the PFI agreement, including an assessment of its risks, should be lower than the PSC. Where there is competition, MoD releases figures for the PSC as early in the process as possible: this is designed to promote competitive bidding and to save on private sector tendering costs where the PSC is likely to be below the private sector bids. See p. 15, Parker & Hartley.

LN1:#20065849 69 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 70 • additional revenue from third party usage.197

Public Sector Comparator

A comparator is a benchmark against which value for money is assessed by comparing the net present value of the bids and the Public Sector Comparator (PSComparator). The PSComparator is a cost estimate based on the assumption that the assets are acquired through conventional funding. The PSComparator is determined by a detailed investment appraisal and should contain all the costs that a conventionally funded service would incur in terms of equipment and running costs. According to MoD policy, all PFI projects involving the use of public money should be tested against a PSComparator.

The public sector comparator is not the sole means of determining value for money.198 Detailed criteria have been developed in order to assess operational effectiveness. Projects may be rejected for PFI because of the unacceptable operational impact. Other factors, particularly the quality of services, are also taken into account as part of the assessment and appraisal processes. 199

In 1997, the MoD’s Equipment Approvals Committee endorsed the staff requirement for Skynet 5.

In March 1999, competitive design study contracts of 20 months’ duration (each valued at £30m) were issued to two consortia, Paradigm Secure Communications (the service delivery entity established by Astrium) and Rosetta Global Communications (the service delivery entity established by Lockheed Martin, BAE Systems and British Telecommunications). There were two advertisements in the MoD Contracts Bulletin. The first was in the Possible Future Purchases Section dated 2 Jul 1997, and the second in the Tenders Invited Section dated 24 Dec 1997. Tenders were sought from six companies, two of whom responded.

The PFI design studies required the two contractors to consider the merits of a range of satellite architectures including, as a fallback, those that would be appropriate for a conventional procurement. MoD assessed the viability of the contractors’ outline PFI proposals in June 2000 and concluded that there were good prospects for the PFI approach. (Skynet 5 was heralded in the Strategic Defence Review (SDR)200 as an important and groundbreaking PFI programme.) Satellite communications can be delivered to users as a service, with much of the risk transferred to the contractor, making it an ideal candidate for PFI. Accordingly, industry was directed to discontinue work being undertaken, as a fallback, on conventional approaches.

The Strategic Defence Review and PFIs

Current UK defence policy is based on the 1998 Strategic Defence Review which outlined future UK defence policy up to 2015. Within this framework, there have been new initiatives in

197 www.ams.mod.uk/ams/content/docs/toolkit/ams/links/pfg_web/library/dpapfu/gnotes/psc.htm 198 Some early public-private arrangements were criticised for a failure to systematically examine public sector alternatives to a private sector supply: it is now standard practice to include such a review — and the process is formalised as the ‘public sector comparator’ (i.e. the hypothetical, whole-of-life, risk-adjusted cost of government delivering the project outputs). PFI procurement is expected to show a saving against the public sector comparator, as well as offering possible non-monetary value (such as schedule advantage). See Technical Note No. 5, How to construct a Public Sector Comparator, Treasury Taskforce – Private Finance. 199 pares 69-70, Select Committee on Defence Fourth Report. 200 www.mod.uk/issues/sdr/

LN1:#20065849 70 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 71 the form of a Smart Procurement policy, the Private Finance Initiative and Public Private Partnerships together with Resource Accounting and Budgeting. Smart Procurement aimed to obtain equipment ‘cheaper, faster and better.’ Integrated project teams involving industry representatives as well as civil servants and service personnel were created; approvals procedures were simplified; and efforts were made to “bear down on defence inflation by pricing contracts of up to five years in cash” and for longer duration contracts allowing price variations on the basis of output rather than input indices (SDR, 1998, p. 41). This policy was implemented by a new organisation, namely, the Defence Procurement Agency, which is the MoD executive agency procuring the Skynet PFI.

In July 2000, the Defence Procurement Agency (Future Satcom Integrated Project Team (IPT)) issued an Invitation to Negotiate (ITN) for the PFI Service Delivery Phase to both companies.

In November 2000, the design phase study for Skynet 5 was completed.201

In January 2001, service delivery proposals from the two bidders were received.

To obtain the best possible bids, MoD conducted “Extended Revise and Confirm” and “Best and Final Offers” rounds.202

In February 2002, following an evaluation of the competing proposals, and on a best value for money basis,203 the MoD chose Paradigm Secure Communications as preferred bidder for the Skynet 5 programme.

When he announced the preferred bidder, UK Defence Under Secretary Lewis Moonie said, “We are getting this service for a lot less than we would have paid if the MoD had followed a traditional procurement route and ordered the satellites itself and operated them using its own personnel. We are also getting a greatly improved service with security and flexibility built in to cope with the growth in military satellite communications requirements we expect over the next few years.” Moonie estimated reductions in the overall cost of Skynet 5 of around £500 million “by applying fresh and innovative thinking.” He cited the program as “a clear example of how we are now using Smart Acquisition principles, getting both better military capability and better value for money.”204 The £500 million reflected the savings expected over the lifetime of Skynet 5, taking into account the changes in acquisition approach that have taken place and other Smart savings measures.

A “robust” 6 per cent saving on this private finance solution is expected as compared with the conventional procurement because of the third-party capacity use. The 6 per cent saving is a comparison with the Public Sector Comparator, on a Present Value basis for the future phases of the programme.

Astrium’s Military Communications Systems Business Division will be responsible for the delivery of the Skynet 5 system to the satisfaction of Paradigm Secure Communications and, in turn, of the MoD. Astrium will be responsible for the design, build and launch of two Skynet 5 satellites, delivered in orbit, supporting:

• UHF and SHF payloads;

201 BT Press Release, April 2001. 202 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. 203 e-mail from DPA SAT IPT, 21 Jan 2003. 204 “Eyes And Ears In Space: Europeans Develop New Space Reconnaissance And Communications Satellites” by Nicholas Fiorenza. Armed Forces Journal International, July 2002.

LN1:#20065849 71 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 72 • secure satellite control link;

• anti-jam capability (nulling antenna);

• multiple, steerable spot beams;

• switchable connectivity; and

• support to legacy terminals.

Paradigm Secure Communications, the special purpose company (SPC) established to deliver SKYNET 5 services, is expected to place subcontracts with the following companies:

• Astrium will be responsible for the replacement of the existing Skynet 4 ground and space assets by the Skynet 5 system;

• Paradigm Services will be responsible for all aspects of Skynet 4 and Skynet 5 service delivery, together with network operation and maintenance;

• BAE Systems will contribute to the tactical ground segment and may provide land transportable terminals;

• Cable & Wireless will provide Paradigm with commercial satcom and leased line services;

• Cogent will provide network baseband and cryptographic equipment, and support system integration;

• General Dynamics Decision Systems will be responsible for Iridium services on the Skynet 5 programme;

• Logica will provide the Skynet 5 Management System and through life IT services;

• Serco will provide network and facilities management services to the Skynet 5 programme;

• Stratos will provide Paradigm with mobile Inmarsat services; and

• Qinetiq will provide specialist technical support.

The first procurement in the Skynet 5 programme was under a contract awarded to BAE Systems C4ISR by Astrium for supply of Talon satellite communications terminals, the first six of which were supplied in October 2002. Fifteen terminals will be supplied in three phases (the second in December 2002 and the third in August 2003). Astrium will provide a further 72 tactical terminals of various types and additional associated communications equipment.205

205 BAE press release, 28 October 2002.

LN1:#20065849 72 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 73 6.2 INSTITUTIONAL STRUCTURES

6.2.1 FORM OF THE PUBLIC AUTHORITY

Under Smart Acquisition206, the Skynet 5 contract will be placed and administered by the Ministry of Defence and specifically by the Satellite Integrated Project Team (SAT IPT) which is currently hosted by the Defence Procurement Agency but which also reports to the DCSA. In due time, once the set-up activities are complete and service delivery commences, the IPT is expected to transfer to the DCSA. It is envisaged that the IPT will remain responsible for the duration of the concession period.207

6.2.2 THE WAY REGULATORY FUNCTIONS ARE DEALT WITH

Skynet needs to co-ordinate its use of the radio frequency spectrum and its orbital slots with other satellite operators, a process conducted under the auspices of the ITU. The Department of Trade and Industry (DTI) is the UK representative to the ITU and assigns frequencies in conjunction with the Radiocommunications Agency.208 Paradigm and its partners, notably Astrium, are expected to carry out the technical and other co-ordination work with the UK government (MoD and DTI principally) which provides the official face with other government representatives and the ITU.

Some functions (for example, those requiring formal interaction by government officials) will continue to be led by MoD staff but, under the PFI approach, as much responsibility for the delivery of services will be passed to the industrial Service Provider (SP). Satellite frequency/orbital slot co-ordination is an example. In this case, the technical input and negotiating strategy will be determined by the SP, but MoD officials will lead delegations when required to do so in international negotiations. Skynet 5 will be required to conform to national laws and government policy.209

Landing rights will need to be negotiated with those individual countries where the MoD wishes to use or install earth stations.210 See section 7.2.2.13 for more detail on this matter.

The EC/ESA will also need to devise an arrangement like that which the MoD and DTI will have with Paradigm/Astrium with regard to the ITU and third countries, where Galileo will need an “official face”. Especially in the context of WTO rules, Galileo will need to be based and under the jurisdiction of a single country, which will act as its administration. The EC will need to have some discussions in collaboration with the (prospective) GOC and the host country in order to ensure that there is a shared understanding, an agreed procedure and philosophy with regard to third country and international regulatory dealings at State level.

6.2.3 NECESSITY OF AN INDEPENDENT MONITORING BODY

An independent monitoring body is not seen as necessary. MoD will undertake “intelligent customer” functions but may call upon independent experts where required. MoD may contract with outside experts to make sure it is getting value for money for the services it pays for.211 “Intelligent customer” functions include understanding and interpreting the military

206 See the footnote in section 4.2.1 207 E-mail from DPA SAT IPT, 21 Jan 2003. 208 The RA is being folded into OFCOM, the new communications super-agency in the UK, towards the end of 2003. 209 E-mail from DPA SAT IPT, 21 Jan 2003. 210 Author interview with DPA SAT IPT, 20 Dec 2002. 211 Author interview with DPA SAT IPT, 20 Dec 2002. Also e-mail from DPA SAT IPT, 21 Jan 2003.

LN1:#20065849 73 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 74 requirement for satellite communications, understanding the charging mechanism and thereby being able to present the service in such a way as to minimise the cost for that service. MoD will retain sufficient expertise to be able to continuously monitor the quality of service it receives and to be able to advise the Service Provider on operational priorities.

Since procurement of the Skynet service involves the use of public funds, audit and oversight of the procurement and implementation inevitably follow. As mentioned in the DFTS case study, oversight of the MoD and its PFIs is provided from various sources, notably;

• the National Audit Office (NAO);

• the Public Accounts Committee; and

• the Select Committee on Defence212.

The Chairman of the latter said that it was relevant for his Committee “to see the factors taken into account when a final decision is made”. Lord Bach, Minister for Defence Procurement, responded “that of course we ought to find a way of debriefing this Committee.”213

6.2.4 PUBLIC SECTOR REQUIREMENTS IMPOSED ON THE PRIVATE ENTITY

Key issues which the Skynet 5 service provider will address include:

• functional interfaces and boundary responsibilities;

• migration of users to new services;

• continuity of service from Skynet 4 to Skynet 5, with no degradation of service for existing users;

• seamless integration of satellite services within both tactical and strategic communications networks as part of the wider Defence Communications System;

• communications service capacity, including growth in capacity throughout the service period;

• use of legacy and future legacy assets;

• response to “stress” (such as electronic warfare or physical attacks) and service protection;

• communications information services to users;

• information services to MoD (to include service planning, system maintenance and financial accounting);

• system coverage which at least matches (and preferably exceeds) that specified in the service specification;

• quality and grade of service;

212 The latter two are committees of members of the UK Parliament. 213 Paras 306-7, Select Committee on Defence Minutes of Evidence. 8 May 2002.

LN1:#20065849 74 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 75 • control and monitoring;

• facilitation of interoperability with allies;

• assurance of service provision;

• provision of system diversity to eliminate single point system failures with sufficient redundancy to guarantee system survivability and availability;

• survivable/hardened space, ground and management (including control) segments;

• appropriate levels of security protection;

• ability to handle surges in communication demands;

• flexibility to meet current and future foreseen and unforeseen deployment patterns;

• a capability to provide communication services in a variety of operational scenarios;

• a robust capability for managing communication resources;

• assured control of all satellites;

• facilities for a small number of service personnel to work alongside service provider staff to provide military judgement and an interface to operational command HQs; and

• in-service date214.

The service provider will be required to act in accordance with normal UK procurement policy (and law). There will be some restrictions on the service provider in areas such as third-party sales215.

6.2.5 OWNERSHIP OF ASSETS

The Skynet 5 contract is a typical PFI where industry pays for and owns the satellites while the MoD and other customers pay only for services.216 The Skynet 5 contract calls for Paradigm to deliver a military satellite communications service to the MoD whenever and wherever required. The existing MoD-owned operational Skynet 4 satellites and infrastructure will be sold and transferred to Paradigm for a nominal fee as part of the deal.217 New assets will be provided and owned by the service provider. MoD-owned land required for service delivery (e.g., MoD anchor stations) will be leased to the service provider218. Paradigm will take over responsibility for the existing Skynet 4 capability in 2003 and will improve the ground segment during the period to 2005. It will procure, own and manage the new Skynet 5 satellites and associated ground segment from 2005219. Services from the first Skynet 5 satellite are expected to begin in 2007.

214 www.mod.uk/dpa/projects/skynet5.htm 215 E-mail from DPA SAT IPT, 21 Jan 2003. 216 Lord Bach at para 296. Select Committee on Defence Minutes of Evidence. 8 May 2002. 217 Author interview with DPA SAT IPT, 20 Dec 2002. E-mail from DPA SAT IPT, 21 Jan 2003. 218 E-mail from DPA SAT IPT, 21 Jan 2003. 219 Statement by Dr Moonie, Secretary of State for Defence, Hansard, 26 Feb 2002.

LN1:#20065849 75 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 76 Table 1: The Skynet 4 satellites

Satellite launch date prime contractor operational status220

Skynet 4 F Feb 2001 Astrium Classified

Skynet 4 E Feb 1999 Matra Marconi Space221 Classified

Skynet 4 D Jan 1998 Classified

Skynet 4 C Aug 1990 Matra Marconi Space Classified

Skynet 4 B Dec 1988 Matra Marconi Space Classified

Skynet 4 A Jan 1990 Matra Marconi Space Classified

Paradigm Secure Communications will contract with Paradigm Services for service delivery and Astrium for the Skynet 5 satellites and ground systems.

Paradigm was formed by Matra Marconi (now Astrium) in 1999. At contract award, both Paradigm companies will come under the ownership of European Aeronautic Defence and Space (EADS).222 Paradigm is, in effect a Special Purpose Company (SPC). Typically in PPP/PFI deals, SPCs are created in order to attract private sector investment into a project specific company with clearly defined terms of reference and risks.223

6.2.6 SECURITY STRUCTURES

Little information is currently in the public domain re what sort of security structures are or will be in place for Skynet 5. The SP will be required to conform to an established System Security Policy. Details of this and the agencies involved cannot be disclosed.224

MoD has “a number” of memoranda of understanding in place with allies re (secure) use of the Skynet satellites.225 Services will be provided to other governments, not to private sector organisations.226

220 Although the operational status of the Skynet 4 satellites is classified, since the life expectancy of the satellites was six to 10 years, it is doubtful that the first three satellites (Skynet-4 A, B and C) are still operational. 221 Matra Marconi Space was a joint-venture company formed by the Lagardere of France and the GEC of the UK. 222 Astrium was formed in May 2000 by the merger of Matra Marconi Space and the space division of DaimlerChrysler Aerospace. Until recently, Astrium was a joint venture of EADS (which owned 75%) and BAE Systems (25%). In Jan 2003, EADS announced that it is acquiring BAE Systems' 25 per cent stake in Astrium. The transaction will be implemented when all regulatory clearances have been obtained. EADS will acquire BAE Systems’ Astrium shares for 84 million. Full control of Paradigm Secure Communications Ltd., formerly held by BAE Systems and EADS, has been transferred to EADS. The Astrium deal is dependent on Paradigm’s securing the Skynet 5 contract from the MoD. If EADS does not achieve financial closure of the Skynet deal, BAE Systems will pay EADS 55m. See “EADS acquires BAE SYSTEMS 25 percent stake in Astrium and takes full control of Paradigm”. Joint EADS-BAE press release, 31 Jan 2003. The largest European company in its sector, EADS was created in July 2000 through the merger of the German DaimlerChrysler Aerospace AG, the French Aerospatiale Matra and the Spanish CASA. 223 E-mail from John Gallimore, Astrium, 27 Jan 2003. 224 E-mail from DPA SAT IPT, 21 Jan 2003. 225 Para 59, Select Committee on Defence Fourth Report. 226 Author interview with DPA SAT IPT, 20 Dec 2002.

LN1:#20065849 76 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 77 The service provider will need MoD permission for off-shore sales and will have to conform to extant UK government export controls. This will be a MoD function to administer in consultation with other government departments but the final decision in some cases could be taken outside of the MoD.227

There are exceptional circumstances MOD may exercise some control over usage of the Skynet system. Examples might be where Paradigm sought to supply service to a customer nation for whom no export licence had been granted or where such a licence had been revoked, or where actions of the service provider have resulted in a major security risk.228

Each user of Skynet 5 will be able to encrypt his or her own information using their own end- to-end cryptographic devices to protect their data. This does not apply to spacecraft control functions, which will be undertaken from the UK and encrypted separately from user traffic.

Provision will be made in the contract for an escrow requirement in respect of certain software intellectual property rights (IPR). This will ensure that continuity of effective industrial support to service delivery is available throughout the concession period.

It is unfortunate (but understandable) that it has not been possible to gather more information about the security structures which are or will be put in place re Skynet 5, as it would be useful to compare MoD security structures or mechanisms with those envisaged for Galileo. The EC and/or GSB may wish to consider the utility of a higher level approach to the MoD to see if some “comparing of notes” would be possible. On the other hand, as the GSB has been chaired by an MoD representative, it may well be that the GSB is already benefiting from MoD insights.

6.3 AGREEMENT BETWEEN THE PUBLIC AND THE PRIVATE ENTITY

6.3.1 AVAILABILITY PAYMENTS AND SHARING OF REVENUES

MoD will make two types of payments to Paradigm. One is a set of fixed availability payments, the other is based on usage of the Skynet service. The availability payments will increase as Paradigm passes each major service milestone, e.g., when it takes over and operates the existing Skynet 4 system, when it improves the existing ground facilities, when it launches new spacecraft. Full service is expected from the new spacecraft within four or five years and full payment will accordingly be over 10 or 11 years, the expected life of the spacecraft 229.

The EC/ESA/JU should also make payments to the Galileo concession based on availability and usage, and in stages, as the MoD is doing re Skynet 5.

In addition to a minimum annual charge for which the MoD will be liable ("Take or Pay" level), the charging regime will cover payments for various types of service.

The cost of the programme to MoD will depend directly on the actual usage of the service throughout the concession period. The MoD has had to consider the minimum cost to which it

227 E-mail from DPA SAT IPT, 21 Jan 2003. 228 E-mail from DPA SAT IPT, 21 Jan 2003. 229 Author interview with DPA SAT IPT, 20 Dec 2002.

LN1:#20065849 77 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 78 is committed and the incremental cost of the extra usage above this level to meet demand at various levels of usage growth. 230

The EC/ESA may wish to consider a variable payment regime like that of the MoD for Skynet services, i.e., payments to the GOC would vary according to the service provided. Thus, for example, PRS service delivery might attract a higher payment than the open service.

Owing to uncertainty about future usage levels, MoD has estimated usage based on defence planning assumptions. This is the most robust method of comparison because it represents the highest assumed level of future operational activity. Therefore, in any year that the operational scenarios do not exceed the assumptions, there will be a lower rate of satellite communications use and, consequently, a net saving231.

The MoD will be the anchor tenant under the PFI contract, but the service will also be available to approved defence and other governmental users from other countries and multinational organisations, such as NATO232. Paradigm’s Business Division will seek business opportunities for military ground systems in Europe and across the world. MoD, as appropriate and at the request of Paradigm, will encourage allies to use spare Skynet 5 capacity. Any benefits achieved by the service provider from third party business will be shared with the MoD233.

Skynet 5 is being designed with NATO and other third party nations’ requirements in mind. It could provide services for Satcom Post-2000, the Alliance program to replace the capabilities of the existing two NATO IV communications satellites, which are expected to be so degraded by 2005 that their use cannot be guaranteed. The Alliance is looking at various possibilities: buying satellites from a national programme, as it did for NATO IV, leasing or paying for services.234 The UK, French and Italian ministries of defence, together with their military satcom providers (Paradigm, Alcatel and Alenia), expect to be able to offer NATO a competitive solution.

6.3.2 RESPONSIBILITY FOR SYSTEM EVOLUTION

The MoD’s requirement is expressed in output specification terms – what it wants to achieve – and leaves the private sector to determine how the requirement is met.235 System evolution rests with the SP, who is expected to respond positively to new MoD requirements.236

6.3.3 SERVICE GUARANTEES

Paradigm does (will) have contractual obligations to guarantee services to MoD. The service provider is committed to deliver the contracted services by the required dates, at the required quality and performance levels throughout the concession; to deliver services in conditions of hostile stress or other potential disruptions to business continuity. Assurance measures built

230 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. 231 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. 232 Astrium press release, 27 March 2001. 233 E-mail from DPA SAT IPT, 21 Jan 2003. 234 “Eyes And Ears In Space: Europeans Develop New Space Reconnaissance And Communications Satellites” by Nicholas Fiorenza. Armed Forces Journal International, July 2002. 235 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. MoD will, however, have access to the design of the military-critical features of the system (such as satellite electro-magnetic pulse hardening and anti-jam measures that cannot be corrected once in orbit). 236 E-mail from DPA SAT IPT, 21 Jan 2003.

LN1:#20065849 78 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 79 into the contract will help ensure that the required military services are put in place. MoD says the assurance mechanisms are “tougher” than any previous asset-based procurement. Among the measures are:

Technical Measures:

• Design review and analysis;

• verification, validation and testing;

• licensing, certification and accreditation;

• service monitoring;

• operational processes;

• training;

• transition/migration planning; and

• business continuity planning.

Commercial Measures

• ‘No service no pay’ principle, and

• service credits.

Financial Measures

• Direct arrangements with the financiers to continue the service and replace the service provider if the service provider fails;

• commitments to obtain insurance for various aspects of the system; and

• the Public Authority’s ability to terminate the contract for ‘anticipatory breach’.237

Financial incentives will also be applied.238

To safeguard the SP's investment, MoD will grant the SP an exclusive market to deliver milsatcom services to the MoD. The SP will also have the right to bid for new service requirements and to deliver these subject to a value for money test. Failure to demonstrate VFM would mean that the MoD is free to procure that service from elsewhere.

The Skynet 5 deal provides for circumstances in which the Skynet capacity may need to be supplemented by capacity from non-military, commercial satellites such as Inmarsat or Iridium or other alternative arrangements agreed with other nations, and the prospective contract will provide for retaining clauses to cover such circumstances.239 (Skynet 4 was also augmented

237 “Effectively Using PPP/PFI In Core Task Areas To Increase The Operational Capability To The Benefit Of Today’s Front Line Solder: The Skynet 5 Case Study.” Simon Kershaw. Presentation at the Defence Partnerships 2002 conference, Brussels. 12-14 November 2002.. 238 E-mail from DPA SAT IPT, 21 Jan 2003. 239 Para 60, Select Committee on Defence Fourth Report

LN1:#20065849 79 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 80 by commercial space segment resources to obtain surge, growth, diversity, specialist services and global coverage.240)

MoD’s service assurances are not exactly the same as the service guarantees envisaged in the Galileo context, although there are some parallels. MoD’s service assurances are designed to ensure that MoD gets what it wants, whereas the Galileo service guarantees will between the GOC (and its SPs) and users of Galileo’s commercial services. Nevertheless, MoD’s sample list of service assurances contain items which the EC/ESA may wish to build into its concession contract for Galileo.

6.3.4 PERFORMANCE MEASUREMENTS

PFI payment plans are typically based on availability and usage, with additional scope for payment reductions if the quality of service delivery is below contracted standards.241

Quality of service will be continuously monitored and payments made will depend on the quality of services actually provided.242 The MoD intends to benchmark Skynet 5 services, although it is not known against which other service providers/satellite systems and whether the MoD itself or external consultants or both will do the benchmarking.

6.3.5 THIRD PARTY LIABILITIES

The responsibility for third party liabilities lies with the service provider.

Questioned about these liabilities, Astrium would only respond that it is not a simple matter of passing third party liabilities to Paradigm. It depends on the issue and the third party which is being referred to. Third party liabilities exist and are a consequence of the approach to risk (liabilities being the consequence of a risk happening).243

6.3.6 RISK MANAGEMENT AND RISK SHARING

PFI is based on a deal between the public and private sectors which allows the private sector to take full responsibility for the design, build, operation and financing of a service to meet the requirement. The contract allocates financial risk broadly in line with this division of responsibilities, although the underlying principle is that each specific risk is allocated to the partner best able to manage it. Compared with a conventional procurement, considerable risk has been passed to the SP.244

Whether PFI delivers value for money should depend not just on a purely financial balance of costs and benefits, but also on whether risk is managed more efficiently. In the defence field, getting the balance of risks wrong does not just undermine the calculation of the cost-benefit of particular projects; it can have consequences for the operational readiness of the Armed Forces, and ultimately for the safety of personnel.245

240 “Eyes And Ears In Space: Europeans Develop New Space Reconnaissance And Communications Satellites” by Nicholas Fiorenza. Armed Forces Journal International, July 2002. 241 www.ams.mod.uk/ams/content/docs/toolkit/ams/links/pfg_web/library/dpapfu/gnotes/sum_use.html 242 E-mail from DPA SAT IPT, 21 Jan 2003. 243 E-mail from John Gallimore, Astrium, 27 Jan 2003. 244 E-mail from DPA SAT IPT, 21 Jan 2003. 245 pares 69-70, Select Committee on Defence Fourth Report.

LN1:#20065849 80 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 81 6.3.6.1 Integration risk

The incorporation not only of the space and ground segments, but also some terminal equipment for land and sea users, within the project boundary will offer advantages as it mitigates the integration risk and allows the service provider, and the customer, to view the business as an end-to-end service. This helped to remove the concerns of bidders and their lenders that the volume of service (and the return they might get) might be affected by any delay or reduction in MoD's satellite communications terminal programmes. 246

6.3.6.2 Insuring risk of satellite loss

At least two Skynet 5 satellites will be launched and will be fully insured against failure. Previous MoD conventional satellite acquisition programmes did not insure the satellites but built and launched three satellites primarily to guarantee against a satellite failure.247 The contractors (and MoD) believe that a satellite failure could be accommodated without jeopardising the service delivered to the MoD, i.e., there would be enough time, if needed, to assemble and launch a third satellite to maintain the contracted operational capability (based on a combined constellation of Skynet 4 and Skynet 5 satellites—the total signal throughput of Skynet 5 is about two-and-a-half times greater than the present Skynet 4 system). The time needed to build and launch a possible third satellite is viewed as less of a risk than it might once have been because Skynet 4 satellites have had operational lives of 6-10 years, longer than previously expected.248 (Skynet 5 satellites will have an expected life of around 12 years.)

6.3.6.3 Contingency risks

If, for any reason, the service provider is unable to deliver, contingency plans, agreed in advance with MoD, will enable a limited number of key functions to be undertaken by MoD service personnel. Currently, the RAF’s Space Operations Squadron controls the Skynet satellite network for all three armed services.249

6.3.6.4 Market risk

Paradigm has taken a risk to acquire third-party customers. MoD is helping to facilitate commercial deals between Paradigm and other allied governments. MoD already has have a number of memoranda of understanding in place which would enable allies to use Skynet.

6.3.6.5 Other risks

The Defence Procurement Agency has identified other risk issues including the following:250

• overcoming security risks when using a privately owned capability;

• risk allocation and management: Determining the long term transfer of ownership of a potential military target;

246 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. 247 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8. 248 Para 61, Select Committee on Defence Fourth Report. 249 ww.mod.uk/aboutus/factfiles/raf.htm 250 Effectively Using PPP/PFI In Core Task Areas To Increase The Operational Capability To The Benefit Of Today’s Front Line Solder: The Skynet 5 Case Study. Simon Kershaw, IPTL, SATCOM Acquisition Team, DPA, UK. Presentation at the Defence Partnerships 2002 conference, Brussels. 12-14 November 2002.

LN1:#20065849 81 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 82 • determining the performance requirements; and

• ensuring the necessary cultural change in the military.

Risks are a commercially sensitive issue. For its part, Paradigm/Astrium said it was not possible to disclose the nature of any risks that exist in the contract. It regards risk transfer and the management of risk as absolutely key to a successful PPP scheme and, therefore, highly commercially sensitive.251

6.3.7 RELATIONSHIP BETWEEN THE PRIVATE ENTITY AND THE COUNTERPARTY TO THE CONCESSION

Prior to contract award (February 2003), the MoD Defence Procurement Agency’s objective is to design a contract and charging mechanism to maximise synergy and commonality of objectives of all key players.252

MoD has established a Skynet 5 Migration Team to co-ordinate the migration of Skynet 4 to Skynet 5 service. Primary activities include due diligence of MoD maintenance records and operational documentation, assets conditioning and performance assessment, co-ordination of engineering plans within continuing communications service provision, and analysis of remote terminals to determine suitability for incorporation into ownership.

Skynet 5 customers will be grouped together according to the capability of the service delivery point. They will be able to request autonomous bandwidth services using their own licensed terminals, point-to-point services, switched network services such as Internet and switched voice services, and broadband services such as broadcasts and cell-switched services. Skynet services will be managed by an integrated project team of the UK MoD and Paradigm within the Defence Communications Services Agency's Global Operations and Security Control Centre in Wiltshire, UK. 253

6.3.8 REMEDIES IN THE CASE OF DEFAULT BY THE PRIVATE ENTITY

Remedies range from service credits in the case of performance shortfalls to contract termination for failure to deliver or, for example, gross breach of security. Other customer nations will have to negotiate their own arrangements with the service provider.254

During operational service, MoD will only pay for services actually received, thus incentivising the service provider. If the services are not delivered to the required quality, a service credit regime will apply. Should the service provider fail to deliver, he would be in default and the contract would be subject to termination. Compensation arrangements would then apply, and the MoD would work with lenders to establish a new service provider. 255

251 E-mail from John Gallimore, Astrium, 27 Jan 2003. 252 Kershaw, op. cit. 253 “Eyes And Ears In Space: Europeans Develop New Space Reconnaissance And Communications Satellites” by Nicholas Fiorenza. Armed Forces Journal International, July 2002. 254 E-mail from DPA SAT IPT, 21 Jan 2003. 255 Memorandum from the Ministry of Defence on Major Procurement Project Survey (March 2002). Select Committee on Defence Appendices to the Minutes of Evidence. Appendix 8.

LN1:#20065849 82 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 83 6.3.9 DURATION OF THE CONCESSION AND BREAK MECHANISMS

The Skynet 5 contract is expected to cover a period of about 15 years but it could be extended if the Skynet 5 satellites last longer than that.256 While 15 years may be regarded as a long duration, especially compared to the 10 year term of the DFTS PFI (which itself was twice as long as the MoD originally considered), there are still other MoD PFI contracts of longer duration, some in fact that stretch over 30 or even 40 years.257

There will be "waypoint vetoes" which will prevent the service provider from proceeding with the spacecraft construction for certain key military features if it is clear that MoD requirements will be compromised. There will be a dispute resolution procedure which will apply if MoD and the SP disagree about the action required at the waypoint and, in extremis, before termination occurs.258

Although Skynet and Galileo are not directly comparable, nevertheless both could and undoubtedly are considered as critical infrastructure. That being the case, the GSB may wish to consider whether any sensitivities in the Galileo spacecraft construction merit a similar series of waypoint vetoes, as is provided for in the Skynet PFI.

6.4 LESSONS LEARNED

Delays in PPP deals are almost inevitable. In February 2002, the Skynet 5 contract was expected to be awarded in August 2002,259 but has been delayed until at least early 2003. The reasons for the delay have not been made public, although Astrium announced a reorganisation in June 2002, one purpose of which was “to improve the focus on customer satisfaction … and in particular Skynet 5” and “to restore acceptable levels of operational and financial performance”. Astrium said the new organisation was “designed to secure clear accountability to the CEO, Antoine Bouvier.”

Lessons learned are not necessarily from bad experience. On the contrary. Good experience can be just as edifying. Here are some of them:

In response to a question re how the Skynet PFI price compares against what might have been the cost of a conventional procurement, Sir Robert Walmsley, Chief of Defence Procurement from the Ministry of Defence, said “we had a competition so we took the best of the two. … there was a clear value-for-money benefit to us. …the public sector comparator is looked at very carefully by lots of people and we are very satisfied that it is extremely robust. …One reason why this PFI worked is that “we kept the option open of going to a conventional procurement until quite late on.”

MoD funded extensive PFI Design Phase studies with both consortia to allow technical risks and business viability to be examined, so the consortia did not have to put in a big premium for risk.

Funding technical studies to minimise the scope for bidders to price in big premiums risks may also be useful in the instance of Galileo. Whether it is useful will depend on such studies as ESA has not already performed. It also depends on who wins the Galileo concession tender, as the winner may wish to fund such studies if it in turn tenders for the satellites. Apart from technical (technology) studies, there may be certain other studies which the EC/ESA may find it useful to fund if there are two or more close bids for the concession.

256 Author interview with DPA SAT IPT, 20 Dec 2002. 257 p. 15, Parker & Hartley. 258 E-mail from DPA SAT IPT, 21 Jan 2003.

LN1:#20065849 83 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 84 The bidders wanted to increase the scope of the PFI contract, to include the terminals on the ground and on ships to make sure that they had all the components of the system under their control. “That allowed them to make extremely sensible efficiencies at the boundaries between the terminals and the space segment and the ground station at Oakhanger [Hampshire].” The result was a 6 per cent saving against the public sector comparator.260 Thus, the flexibility of the public authority in determining the contours of this PFI worked to its benefit and that of the service provider. MoD will get a complete, end-to-end service and save some money at the same time.

On lessons learned, the DPA commented that doing PFI is not easy, straightforward or quick. It is important to allow enough time (i) to understand the requirement both now and in future and to articulate this in service delivery terms (not specifying an asset!); (ii) to fully evaluate the bidders’ technical and business proposals, (iii) to fully explore the sensitivities of the business case to both changes in customer requirements and to changed economic conditions; (iv) to understand and capture all factors that need to be taken into account in assessing value for money; and (v) to understand what will take place at the end of the concession and how to avoid lock-in.261

The key lessons learnt from the Paradigm perspective lie in risk identification, allocation and management (and associated liability management) although this is too commercially sensitive to be disclosed in any detail. A second area is in organisational structures, where numerous options were evaluated and the optimum structure for Skynet 5/Paradigm was identified bearing in mind such issues as risk allocation, attracting investment and operational activities amongst others. Astrium further commented that “The organisation structure for Skynet 5/Paradigm is not optimum for Galileo and an alternative is required. The basic structure (and process to get there) proposed by PricewaterhouseCoopers in its report is most relevant here.”262

259 www.mod.uk/dpa/projects/skynet5.htm 260 Sir Robert Walmsley at para 306. Select Committee on Defence Minutes of Evidence. 8 May 2002. 261 E-mail from DPA SAT IPT, 21 Jan 2003. 262 e-mail from John Gallimore, 27 Jan 2003.

LN1:#20065849 84 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 85

7 INMARSAT

7.1 BACKGROUND

Inmarsat owns and operates a global satellite network and provides services through a worldwide group of service providers who offer mobile communications services in the air, on land and at sea to about 250,000 registered users (as of February 2003).263

Inmarsat’s origins stretch back to 1973, when the International Maritime Organisation (IMO), a UN agency, decided to convene a conference with the object of establishing a new maritime communications system based on satellite technology. The Conference first met in 1975 and held three sessions, at the third of which, in 1976, the Convention on the International Maritime Satellite Organization was adopted, together with an Operating Agreement. The Convention applied to Parties (member States) and the Operating Agreement to Signatories who were appointed by the Parties to invest in the organisation. Both instruments entered into force on 16 July 1979.

The Convention defined the purposes of Inmarsat as being to improve maritime communications, thereby assisting in improving distress and safety of life at sea communications, the efficiency and management of ships, maritime public correspondence services, and radiodetermination capabilities.264 This purpose was later extended through amendments to the Convention and Operating Agreement to provide the space segment for land mobile and aeronautical communications. The Convention and Operating Agreement were amended several times. One of the amendments changed the name of the Organisation to the International Mobile Satellite Organisation, abbreviated to Inmarsat, to reflect the extension of its services from the maritime sector to other modes of transport.

The Organisation consisted of an Assembly, composed of all Parties, each with one vote; a Council composed of 22 representatives of Signatories, where decision-making was weighted according to investment share; and a Directorate headed by a Director General.265

Investment shares were determined on the basis of utilisation of the Inmarsat space segment. Headquartered in London, Inmarsat began operations in 1982.

Inmarsat's obligation to provide maritime distress and safety services via satellite was enshrined within the 1988 amendments to IMO Safety of Life at Sea (SOLAS) Convention which introduced the Global Maritime Distress and Safety System (GMDSS). Ships sailing in specified sea areas are required to carry Inmarsat communications equipment for distress and safety calls and to receive navigational warnings. At present, the Inmarsat system is the only mobile-satellite system recognised by SOLAS Contracting Governments for use in the GMDSS.

As an intergovernmental satellite organisation (ISO), Inmarsat, its Signatories and employees enjoyed certain privileges and immunities, such as being exempt from taxation on revenue, including import duties and taxes.266 In the United States, however, these privileges and

263 Inmarsat serves a wide range of customers, however, like the DFTS and Skynet, its single biggest customer is the military. See p. 2, Submission by Warren Grace before the US Senate. 264 Article 3, Inmarsat Convention. 265 Of the 22 representatives, four were required to be elected on the basis of geographic representation and to represent the interests of developing countries. Article 13, Inmarsat Convention. 266 Former Director General Warren Grace was quoted as saying “Suggestions that we have enjoyed special access to markets irritate me.” He denied that Inmarsat has ever benefited from any immunities or special

LN1:#20065849 85 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 86 immunities were among the factors which ensured the domestic market was closed (with some limited exceptions, for example, where FCC authorised use of Inmarsat in emergencies) to provision of Inmarsat services.

7.1.1 APPROACH IN THE SELECTION OF THE PRIVATE SERVICE PROVIDER

7.1.1.1 Why Inmarsat had to restructure

Despite the amendments, it became obvious in the early 1990s that more fundamental changes to the Organisation were necessary.267 Emerging competitors complained that Inmarsat enjoyed unfair advantages. Article 8 of the Convention, which required other satellite systems to co-ordinate with Inmarsat to ensure technical compatibility and to avoid significant economic harm to Inmarsat, was an irritation.

Even within Inmarsat, there was a desire for change. Decision-making was often slow. Developing consensus for changes in an organisation made up of 84 different countries, and scores of telecommunications entities, was “extremely difficult”, according to former Director General Warren Grace. Different economies, languages, cultures, needs, expectations, and priorities made for an extraordinarily complex and time-consuming decision-making process.268

Signatories’ shareholdings were linked to utilisation of the space segment, so that they could not have ownership stakes in the Organisation according to their interest, nor could they sell or trade shares. Nor could the organisation raise money outside the Signatories. Inmarsat’s ISO financial structure was regarded as arcane, restrictive, an inhibitor to growth. The institutional arrangements restrained Inmarsat from being a truly effective competitor.269

As the Organisation grew and as the space segment and new developments increased in costs, Signatories were not always able to reach consensus. The USSR Signatory attempted several times to get agreement on use of Proton launchers which would have saved Inmarsat many millions of dollars, but their offers were rebuffed by the US Signatory acting on instruction of the US Party for many years. ESA and Marconi made an offer regarding a new spot beam satellite, called Aramis, at a time when Inmarsat still had only global beam

privileges. See “Inmarsat plc braced for satellite industry blast-off”, November 1998. www.thebaltic.com/archive/98/november/article1.html. Comsat was of the view that it was immune from suit and legal process only when acting in its capacity as U.S. Signatory, that it had no immunity with respect to its commercial provision of services as a carrier, or in any other non-Signatory capacity. Comsat disagreed that its limited immunity conferred any competitive advantage, because that immunity did not apply to Comsat’s conduct in the marketplace; it applied only to its conduct as a Signatory, and in that role Comsat was subject to U.S. government instruction. Nevertheless, in its 1998 DISCO-II Order, the FCC held that Comsat’s limited Signatory immunity conferred a competitive advantage that warranted its exclusion from the U.S. domestic market. See below for more details. See also Comments Of Comsat Corporation Before the National Telecommunications and Information Administration, Docket No. 990405086-9086-0. 267 The first glimmering of change came at Inmarsat’s Seventh Assembly Session in Lisbon in October- November 1989 when Olof Lundberg, Inmarsat's first Director General, spoke of the need for making structural changes to Inmarsat, in order to free it to act in a more commercial manner, in response to the changing telecommunications environment. Subsequent consideration of possible changes by some Parties, the Council and the Director General led to the formal start of the restructuring process at Inmarsat’s Eighth Assembly Session in Canberra in September 1991. The Assembly set up an Intersessional Working Group (IWG) of Parties and Signatories “to review the objectives and processes of Inmarsat in view of the changing telecommunications environment and the challenges of competition.” See paras 11-12, Sagar, 1999. 268 pp. 3-4, Submission by Warren Grace to US Senate, 10 Sept 1998. As an example, not cited by Mr Grace, the amendments to the Convention and Operating Agreement relative to land mobile-satellite services, adopted by the Assembly in January 1989, only entered into force in June 1997. The comparable aeronautical amendments took four years to enter into force (in 1989, but adopted by the Assembly in 1985. 269 “World's first satellite company prepares for competition” by Nancy Gohring. Telephony. 14 Dec 1998.

LN1:#20065849 86 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 87 satellites, a development favoured by the Europeans, but not other Signatories. Inmarsat-P, the handheld satellite terminal, had to be developed in a spin-off organisation (ICO) with the result that Inmarsat found itself in the anomalous position of creating a competitor.270, 271 With shareholders entitled to a maximum shareholding of 25 per cent, it was possible for just three Signatories to veto any proposal.

Council Signatories did not have a fiduciary responsibility to Inmarsat so that they often looked at new proposals or decisions in terms of how their individual organisations would benefit even if those decisions were not in the best interest of Inmarsat itself. The lack of fiduciary responsibility was compounded by the fact that Parties could instruct their Signatories to take or support decisions which were not necessarily in the best interests of the Signatories let alone Inmarsat.

Signatories also did not like the fact that they were exposed to unlimited liability under Article XI of the Operating Agreement. Parties, on the other hand, had no such exposure under Article 22 of the Convention.

Relations between Signatories and the Directorate were sometimes strained. The Signatories were the “customers” (as well as owners) of the Directorate, hence they did not like and did not want the Directorate to have any direct contact with customers or prospective customers. Many Signatories, however, were not particularly active in marketing their services, and those that were tended to market their services as “Comsat” services or “BT” services rather than Inmarsat services. For a long time, the Signatories resisted attempts by the Directorate to advertise generic Inmarsat services.

The Inmarsat Council tended to engage in “micro-management” of the Directorate. Indeed, several Signatories had offices on the premises of Inmarsat headquarters so that they sometimes had intimate knowledge of the Directorate workings.

From a system point of view, Inmarsat needed only two land earth stations (LESs), one of which would back up the other, in each of its four ocean regions. However, there were many times more LESs than were actually necessary, and since they were not owned or under the control of Inmarsat, Inmarsat was obliged to service them all and to provide carrier signals to all. Most of the LESs were not profitable operations.

270 Some Inmarsat Signatories refused to contribute to the large capital needed for the Inmarsat-P project, on a mandatory basis according to their investment shares as required under the Operating Agreement. They wanted to choose the level of their own investment. Some felt that the business risks associated with the undertaking were too great, particularly in the absence of limited liability for the Signatories. Access to external sources of capital was not possible under the Operating Agreement. Other Signatories which were mainly maritime communications providers saw S-PCS as primarily a land mobile service, and not of direct interest to them. Some Signatories or their Parties required a “level playing field” among all S-PCS competitors, and did not want Inmarsat-P to benefit from Inmarsat’s privileges and immunities or by cross-subsidisation from its other revenues. Another worry was that the cumbersome governance procedure through the Inmarsat Council would be inadequate to manage the project with the decisiveness needed to match competition. As a result, the Inmarsat Council decided that the Inmarsat-P service should be provided through a separate, affiliated, private limited company under national law. See paras 23, 24, Sagar, 1999. 271 ICO Global Communications Ltd was set up in 1995 and began launching satellites in 2001. Initially, Inmarsat had a 15 per cent share in ICO and two directors on the Board. However, as time went on, its stake declined and eventually became worthless when, in August 1999, ICO filed for protection under Chapter 11 of the United States Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware. See ICO press release, Aug 1999. Before ICO sought protection under the bankruptcy code, Inmarsat Holdings Ltd. owned 9.537% of its shares. When ICO emerged from bankruptcy, this ownership interest was reduced to less than one tenth of one per cent. In fact, the Board of Inmarsat Holdings Ltd. wrote off the entire amount of the investment. See Comments of Inmarsat Ltd. before the NTIA, 8 May 2000.

LN1:#20065849 87 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 88 There was some dissatisfaction that Inmarsat could not retain its IPR. Under Article 21 of the Convention, the Organisation was required to disclose to any Party or Signatory the IPR (described as inventions and technical information) and any Party or Signatory could further disclose that IPR to anyone else, including competitors.

During the 1990s, Parties, Signatories and the Directorate debated the extent of structural changes that should be made to Inmarsat and how those changes should be made. It was necessary to reconcile widely differing policies and interests of Inmarsat member States and Signatories. Many of the larger shareholders, with developed national telecommunications structures or privatised systems, wanted a private entity competing equally with other satellite system operators. Others, particularly smaller shareholders, developing countries and some former socialist states, wanted to retain the IGO272 structure, which they felt would enable them to retain a greater voice in the affairs and protect the continuation of Inmarsat’s services in their territories. 273

Inmarsat’s path towards privatisation was not smooth or easy. There was resistance from some of its member countries which did not have market economies, and many Inmarsat Signatories were not private companies. Instead, they were the public telecommunications operators within their home countries. For many of them, at least at the outset, privatisation was not seen as an appropriate operating structure for Inmarsat.274 Former Director General Warren Grace said, however, that if Inmarsat were not privatised, its shareholders would have baulked at putting up any more money.275

Various models were considered, including a so-called revitalised Inmarsat, an international public corporation and a national law company. The latter, proposed by the UK, was the model finally chosen.276

Outside legal counsel was brought on-board to assist Inmarsat from an early date. By January 1994, Freshfields had been retained following a competitive bidding process. Subsequently, the Council brought in Slaughter & May for independent advice in addition to the advice the Inmarsat Directorate was getting from Freshfields. Watson, Farley & Williams completed the trio of outside counsel. WFW had already previously worked for Inmarsat in 1988 in assisting the development of tax-based finance leases of Inmarsat’s second generation satellites. WFW had also been selected as a result of a competitive tender. Their role in the subsequent privatisation was to advise on the novation of the finance leases.277

An investment banker, SBC Warburg Dillon Read (SBC), was hired by the Council to provide financial and strategic advice, due diligence and review of Inmarsat's business plans with a view toward the privatised organisation's ability to raise capital in public markets.278

The key elements of Inmarsat’s privatisation included:

(a) Preservation of Inmarsat’s GMDSS services

The GMDSS services are protected via a contract with IMSO whose responsibility is to ensure that these and Inmarsat’s other public service obligations are met.

(b) An independent board of directors with fiduciary responsibilities

272 The abbreviations IGO and ISO are used interchangeably in this report. 273 Para 28, Sagar, 2002. 274 Pp. 2-3, Submission by Warren Grace to US Senate, 10 Sept 1998. 275 “Inmarsat plc braced for satellite industry blast-off”, Information Technology, November 1998. www.thebaltic.com/archive/98/november/article1.html 276 See Sagar, 1999, which describes the road travelled by Inmarsat towards its privatisation. 277 E-mail from Alan Auckenthaler, Inmarsat General Counsel, 20 Jan 2003. 278 “Comsat backs Inmarsat ”. Space Daily. 16 March 1998.

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(c) Elimination of privileges and immunities

These rights were crucial to the founding and early success of Inmarsat, but they were not appropriate for a competitive enterprise. They were eliminated upon transition to the privatised structure.

(d) Broadened ownership (and dilution of ownership shares)

Provision was made for the immediate introduction of new investment capital through the identification of strategic investors. A commitment was made for an initial public offering (IPO) of stock through public exchanges within approximately two years of privatisation. 279

In April 1998, the Inmarsat Assembly adopted amendments to the Inmarsat Convention and Operating Agreement which were intended to transform the Organisation’s business into a privatised corporate structure, while retaining intergovernmental oversight of certain public service obligations and, in particular, the GMDSS.280 The new structure comprised two entities:

• Inmarsat Ltd, a public limited company which forms the commercial arm of Inmarsat; and

• International Mobile Satellite Organization (IMSO), an intergovernmental body established to ensure that Inmarsat continues to meet its public service obligations. IMSO replaced Inmarsat as observer at IMO meetings.

The Assembly and Council subsequently decided to implement the amendments as from April 1999, pending their formal entry into force. The amendments to the Convention formally entered into force on 31 July 2001 and became binding upon all Parties, including those which had not accepted them. The Operating Agreement terminated on the same date.281

A key element in the privatisation of Inmarsat was the provisional application of the necessary amendments. Inmarsat had previously amended its Convention and Operating Agreement and, for example, had begun providing aeronautical and land mobile satellite services before the amendments had actually come into force, a process which required adoption by two- thirds of the Parties and Signatories representing two-thirds of the investment share.

Although provisional application is well established in interstate treaty practice, as reflected in Article 25 of the 1969 Vienna Convention on the Law of Treaties, its use by decision of a supreme body of an IGO such as the Assembly was not so extensive. Analysis of the problem by legal experts, taking into account advice from a leading treaty lawyer,282 led the Council to recommend that the Assembly decide to implement the amendments provisionally, subject to eventual formal entry into force. While many Parties accepted provisional application, others were precluded by their constitutions from doing so without special legislation, particularly as the Convention did not itself provide explicitly for provisional application. For these countries, practical solutions were proposed whereby a provisional application decision by the Assembly would be subject to the internal laws of each Party. This, it was argued, would enable them to

279 pp. 4-5, Submission by Warren Grace to US Senate, 10 September 1998. 280 See para 4.1.1, IMSO Assembly Report, 19 September 2002. 281 para 4, Proposed Amendments to the Convention on the International Mobile Satellite Organization. Submission by IMSO. Maritime Safety Committee. MSC 75/11/4. xx March 2002. 282 S Rosenne, an Israeli professor of law, one of the leading international lawyers and publicists in treaty law and many other fields, including the UN Law of the Sea Convention.

LN1:#20065849 89 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 90 participate in the restructuring, including the exchange of their Signatories’ investment shares for ordinary shares in the Company, without being forced to oppose the decision.283

This was an innovative use of Article 25 of the Vienna Convention on the Law of Treaties, and represents an evolution of public international law on the subject, opening the way for other organisations wishing to break free of the straitjacket of treaty law when making fundamental changes to their structures.284

The restructuring of Inmarsat involved the incorporation of holding and operating companies, Inmarsat Holdings (“Holdings”) and Inmarsat Ltd (“the Company”), located in England and registered under British law on 15 April 1999. On the same day, a Headquarters Agreement between the UK Government and IMSO was signed. A Public Services Agreement between IMSO and the privatised Inmarsat was also executed with immediate effect. The Inmarsat satellites and all other assets of the former IGO were transferred to Inmarsat Ltd, a wholly owned subsidiary of Inmarsat Holdings Ltd. 285

Under the privatisation, the former treaty-based investment shares of Signatories in the Inmarsat ISO were converted to shares of stock in Inmarsat Holdings. Inmarsat Ventures (ex- Holdings) is governed by a board of directors and chairman, who are elected by its shareholders and who have a fiduciary responsibility to the Company. Inmarsat now is subject to all the same laws, taxes and regulations that govern any other private company in the UK.286

Thus, the member States and Signatories of Inmarsat pioneered the first ever privatisation of an intergovernmental organisation, while adhering to the continuous provision of the public service obligations and governmental oversight.287

7.1.1.2 The Restructuring Agreements

In addition to the Council and Assembly decisions, the restructuring of Inmarsat from an intergovernmental satellite organisation to a privatised company required many different agreements (collectively known as the Restructuring Agreements) as well as the satisfaction of a large number of “conditions precedent”, as set out in a Master Transition Agreement. The Restructuring Agreements were needed to effect the “grant, conveyance, transfer, sale and delivery of all of the right, title and interest of the IGO in the business assets to the Company”.288 The agreements comprise the following:

• Master Transition Agreement;

• Master Novation Agreement;

• Trust Deed 1;

• Trust Deed 2;

283 Para 64-5, Sagar, 1999. 284 Para 33, Sagar, 2002. 285 Para 5, Proposed Amendments to the Convention on the International Mobile Satellite Organization. Submission by IMSO. Maritime Safety Committee. MSC 75/11/4. xx March 2002. 286 Inmarsat Ventures and Inmarsat Ltd are often referred to collectively in this text as simply Inmarsat. Where a distinction is necessary to understanding, references are made specifically to Inmarsat Ventures or Inmarsat Ltd. 287 Para 3, Proposed Amendments to the Convention on the International Mobile Satellite Organization. Submission by IMSO. Maritime Safety Committee. MSC 75/11/4. xx March 2002. Intelsat and Eutelsat followed suit two years later. 288 Article 3.1(i)(x), Master Transition Agreement.

LN1:#20065849 90 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 91 • Business Transfer Agreement;

• Public Services Agreement;

• Licence Agreement;

• Shareholders Agreement; and

• Land Earth Station Operators (LESO) Agreement.

The Master Transition Agreement is the principal agreement, and it is an agreement between the International Mobile Satellite Organisation, established by the Convention of July 1979, a set of newly created Inmarsat companies established under the UK Companies Act of 1985, and the Signatories. The other agreements, except the LESO Agreement, were attached as schedules to the MTA. Under the Master Transition Agreement, Inmarsat committed to retain an investment banker within 180 days of privatisation for the purposes of preparing an IPO of stock. However, the expected IPO has been delayed several times in view of market conditions. See section 7.2.2.12 for more details.

The Master Novation Agreements were between the IGO, the Company and each Signatory relating to the novation of Signatory contracts, which included any contract, licence, non- disclosure agreement, space segment lease and any other contractual arrangement between the IGO and a Signatory. The so-called “Standard Novation Agreements” were between the IGO, the Company and third party contractors effecting the novation of contracts between the IGO and the third party contractors. Under the Novation Agreements, the IGO ceased to be a party to any contract and was replaced by the Company.289

The trust deeds were created for countries where their shareholder couldn't hold the shares directly but had to hold them through a trust, e.g., Iraq and Yugoslavia. Trust Deed 1 was a deed executed by Inmarsat Holdings, the Trustee and such Signatories as were unable to subscribe for the Holdings Ordinary Shares on completion. Trust Deed 2 was executed by each of Holdings and the Trustee in relation to such Signatories as had not signed or otherwise agreed to become subject in all respect by completion to the provisions of the Master Transition Agreement and the Shareholders Agreement.

The Business Transfer Agreement was between the IGO and Inmarsat Ltd (“the Company”) relating to the transfer of the business from the IGO to the Company.

The Public Services Agreement (PSA) was between the IGO, Holdings and the Company pursuant to which each of Holdings and the Company undertakes to implement certain public service obligations.

The Licence Agreement was between the IGO and the Company relating to the use of the Inmarsat name and logo.

The Shareholders’ Agreement was between Holdings and the Shareholders, by means of which the shareholders agreed to support the company to carry out an IPO. They agreed that if they sold their shares to another company that that new company would sign up to the Shareholders Agreement if the IPO hadn't happened by that time.290

The LESO Agreements were between the Company (Inmarsat Ltd) and each of the LES operators. The LESO Agreement authorises the LES operators to provide services via Inmarsat. Pursuant to the LESO Agreement, Signatories with Land Earth Stations have a

289 Article 2, Master Novation Agreement. 290 E-mail from Alison Horrocks, 16 Jan 2003.

LN1:#20065849 91 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 92 non-exclusive right to provide mobile satellite services using Inmarsat Ltd’s existing satellites. Signatories, such as Comsat, no longer had the exclusive right to provide space segment for traffic originating in the United States. (Currently, several ex-Signatories provide Inmarsat services in the United States.) The LESO Agreement is, in effect, a distributor agreement guaranteeing that for five years after restructuring, the Company is committed to providing the existing range and type of services at a steadily reducing cost to those LES Operators. The Company will also, during that period, continue to act as wholesaler of such services and will not be able to compete as an LES operator or a reseller of services. The existing LES Operators sought the protection of this Agreement in order to preserve their investments and business in their LESs, once their control of services and pricing policy in the Inmarsat Council had passed to the Company. For them, it was a sine qua non of restructuring. Ideally, the Agreement should have reflected a balance of interests between the LES Operators and the Company. However, the Agreement as it stands may inhibit the maximisation of the Company's business opportunities, for example, by limiting flexibility in managing its distribution outlets and its service portfolio, and in constraining its charging policy. At least, in the long term, the Agreement does not restrain the introduction of new services by the Company, which is where its future viability lies.291

7.2 INSTITUTIONAL STRUCTURES

7.2.1 FORM OF THE PUBLIC AUTHORITY

The residual intergovernmental organisation (IMSO) continues with 87 parties,292 operating through an Assembly of Parties (which meets once every two years), its Advisory Committee and a small Secretariat, headed by a Director who is the legal representative of the Organisation. Under the relevant provisions of the Convention, as amended, the Public Services Agreement and the Articles of Association of the Company, IMSO is charged with overseeing, and under some circumstances may enforce fulfilment of some of the Company’s public service obligations and, in particular, GMDSS services. In performing this role, IMSO acts as the natural ally of IMO and watchdog of proper provisions and implementation of IMO’s requirements in respect of GMDSS by Inmarsat Ltd. 293 To facilitate these functions, an Agreement of Co-operation has been concluded between IMSO and IMO. Under a similar Agreement with the International Civil Aviation Organization (ICAO), IMSO ensures that Inmarsat Ltd. takes into account the applicable ICAO Standards and Recommended Practices (SARPs) and regularly informs ICAO accordingly. 294

IMSO’s purpose is to ensure that the basic principles set out in Article 3 of the Convention are observed by the Company, namely:

(a) ensuring the continued provision of global maritime distress and safety satellite communications services;

(b) providing services without discrimination on the basis of nationality;

(c) acting exclusively for peaceful purposes;

291 Para 53-4, Sagar, 1999. 292 Inmarsat had 86 Parties prior to privatisation. 293 Para 1.5, Information on the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO) to the IMO Sub-Committee on Radiocommunications and Search and Rescue. September 2000. 294 Para 6, Proposed Amendments to the Convention on the International Mobile Satellite Organization. Submission by IMSO. Maritime Safety Committee. MSC 75/11/4. xx March 2002.

LN1:#20065849 92 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 93 (d) seeking to serve all areas where there is a need for mobile satellite communications, giving due consideration to the rural and the remote areas of developing countries; and

(e) operating in a manner consistent with fair competition, subject to applicable laws and regulations.

The Public Services Agreement includes the following provision (Article 2.1.2) as a means of giving effect to the requirements of Article 3 of the IMSO Convention:

(a) The Company is obliged to continue to make available space segment capacity, and to maintain and support applicable ship earth station standards, services and systems, including Inmarsat-A, B, C and E services, and any other Inmarsat standards, services or systems included in, and complying with, requirements of the SOLAS Convention, and related IMO resolutions and performance standards, to enable maritime distress and safety communications to be available to ships at all times and providing the capabilities of:

(i) transmission and reception of distress and safety communications using direct-printing telegraphy, telephony, data communications, initiation and reception of distress priority calls, transmissions of shore-to-ship distress alerts including those directed to specifically defined geographical areas, and transmission and reception of general radio-communications using radiotelephony, direct-printing telegraphy or data communications;

(ii) transmission of maritime safety information by the Inmarsat enhanced group calling system; and

(iii) transmission by satellite emergency position-indicating radio beacons (satellite EPIRBs) of distress alerts through the Inmarsat geostationary service.

(b) In addition to those with IMO and ICAO, IMSO has an agreements of co-operation or administrative arrangements the ITU. The Director attends meetings of the United Nations Committee on the Peaceful Uses of Outer Space (UNCOPUOS) and has supplied information on how IMSO works to his counterparts at the European Telecommunications Satellite Organisation (Eutelsat IGO) and the International Telecommunications Satellite Organization (ITSO).295 IMSO also has an Understanding on the Secretariat of the International COSPAS-SARSAT Programme. (Like the IMSO Secretariat itself, the COSPAS-SARSAT Secretariat is headquartered at the Inmarsat building in central London and holds Party meetings there.)

7.2.1.1 Special Share

A Special Share in Inmarsat Holdings (Inmarsat Ventures) was issued to IMSO on 15 April 1999. The Special Share entitles IMSO to veto changes to specified parts of the Inmarsat Ventures Memorandum and Articles of Association that relate to GMDSS and the other public service obligations.296 IMSO may, at any time, after consulting the Company and subject to the provisions of the UK Companies Act, require the Company to redeem the special share at par by giving written notice and delivering the relevant share certificate.297 As a shareholder in Inmarsat Ventures, the IMSO Secretariat receives quarterly reports, the annual review, and

295 Eutelsat was privatised on 2 July 2001 and INTELSAT on 19 July 2001. Eutelsat and ITSO are the equivalents of IMSO. 296 Para 42, Sagar, 1999. 297 p. 54, Inmarsat Ventures Annual Report 2001.

LN1:#20065849 93 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 94 other reports, correspondence and press releases from the Company containing information of a commercial nature.298

The Special Share and the rights of the Special Shareholder (i.e., IMSO) are referenced in the Articles of Association of Inmarsat Ventures. Articles 26-30 say that the Special Share issued to the Organization on 15 April 1999 is not be transferable. A variation in the rights of the Special Shareholder can not be made without its written consent. A variation would include:

(a) amendment or removal of:

(i) Clause 3(2) of the Memorandum as this relates to the provision and support by the Company of maritime and distress and safety services;

(ii) Articles 26 - 30 (those referenced here);

(iii) Article 86, which obliges the Board upon request of the Special Shareholder to convene an extraordinary general meeting so long as the Special Shareholder has previously consulted with the Board re the matter to be raised at the meeting;

(iv) Article 151(a), which is a limitation on the powers of the Board in regard to any proposal which may have a material adverse effect upon the provision by the Company or Inmarsat Ltd of any of the Public Service Obligations; and

(v) Article 154, which identifies the public service obligations, otherwise known as the basic principles;

(b) the voluntary winding-up of the Company unless the Company is unable to pay its debts; and

(c) a decision by the Board to amend or remove Articles 19(A)(b) or 19(B) of the Articles of Association of Inmarsat Ltd or Clause 3(1) of the Memorandum of Association of Inmarsat Ltd. These Articles and Clause relate respectively to Inmarsat’s public service obligations and to the objects (purpose) of Inmarsat as being inter alia to provide global distress and safety services.

The Special Shareholder is entitled to receive notice of, attend and speak at any general meeting or any separate meeting of the holders of any class of shares, but the Special Share shall carry no right to vote nor any other rights at any such meeting. If the Company is wound up, the Special Shareholder is entitled to repayment of the capital on the Special Share in priority to any other member.

The Special Share confers no other right to participate in the capital, and no right to participate in the profits, of the Company.

The EC and/or JU may wish to consider the utility of a Special Share in the Galileo Operating Company, to be held by a Galileo Public Authority (GPA), as one mechanism to ensure certain specified rights like those of the Inmarsat Special Shareholder and to be able to track “from the inside” what the GOC is doing.

298 Para 10.3, IMSO Assembly Report, 19 Sept 2002.

LN1:#20065849 94 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 95 7.2.1.2 Expanding the scope of IMSO

Currently, the IMSO oversees only Inmarsat, particularly with regard to Inmarsat's provision of GMDSS services. The IMO, which has responsibility for establishing maritime safety standards, has thus far only recognised Inmarsat as a provider of the satellite component of the GMDSS. However, IMO may recognise additional satellite telecommunication companies as GMDSS providers in the future and, that being the case, questions have arisen as to what role, if any, IMSO would play.

In February 2002, the Party of Denmark proposed amendments to the Convention which focus, inter alia, on the need to enlarge the scope and oversight of IMSO to include future providers of GMDSS satellite services.299 At its September 2002 session, the IMSO Assembly created an Intersessional Working Group (IWG) to undertake a detailed study of the role of IMSO in respect of the GMDSS, aeronautical safety services, and service to rural and remote areas of developing countries, including the principle and legal methodology of a possible extension or expansion of IMSO's mandate and to make recommendations to the next Assembly in October 2004. 300

If adopted, the Danish proposals would have the effect of making IMSO’s oversight role in relation to the GMDSS applicable to any mobile satellite communications provider approved by IMO as a provider of GMDSS services.301

7.2.2 THE WAY REGULATORY FUNCTIONS ARE DEALT WITH

This section identifies the principal regulatory functions affecting Inmarsat. It is not, of course, complete by any stretch of the imagination. It does not, for example, cover the privacy or data protection requirements with which it must comply.

7.2.2.1 The Public Services Agreement

The relationship between the Organisation and the Company is governed by the Public Services Agreement which requires Inmarsat to “take into account the relevant international standards, regulations, resolutions, procedures and recommendations of the International Maritime Organization and the International Civil Aviation Organization, and [to] observe the relevant provisions of the Constitution and the Convention of the International Telecommunication Union and the regulations made thereunder.”302

The PSA is a unique instrument in providing a regulatory mechanism whereby member States will, through an IGO, oversee and enforce the activities of a nationally incorporated multi- national company. It is governed by English law, and gives the IGO effective enforcement remedies, including specific performance and injunctive relief, in the event of failure by the Company to observe most of its obligations. The PSA also requires the Company to fund the IGO’s Secretariat to the extent of £300,000 per year initially plus a contingency fund of £100,000 for enforcement costs. The Agreement may be terminated by the Company when competing systems are permitted by IMO to satisfy its requirements for maritime distress

299 Proposed Amendments to the Convention on the International Mobile Satellite Organization. Submission by IMSO. Maritime Safety Committee. MSC 75/11/4. xx March 2002. 300 Para 7.11, IMSO Assembly Report. 19 September 2002. 301 Para 10, Satellite Services (Inmarsat and COSPAS-SARSAT). Analysis and assessment of the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO). COMSAR 7/5/2. 8 November 2002. 302 Article 3, PSA.

LN1:#20065849 95 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 96 and safety satellite communications. This prominence given to IMO’s role under this Agreement is another unique feature of the restructured Inmarsat.303

Under Clause 4 of the PSA, a Public Services Committee (PSC) was established, the aim of which is to discuss and resolve all issues concerning provision of GMDSS services by the Company and all other matters concerning performance by the Company of its public service obligations.304 It meets four times a year, and the chairmanship of the Committee alternates between the IMSO Director and a representative of Inmarsat Ltd.

The IMSO-Inmarsat Public Services Committee could be a model for the EC/ESA/JU to implement with the Galileo Operating Company. MoD has a similar arrangement with BT in regard to the DFTS, and attributes a good measure of the success so far achieved to this mechanism. Like the PSC, the EC and the GOC could, inter alia, discuss and resolve any issues relating to the GOC’s implementation of its public service obligations.

7.2.2.2 Companies Act

The UK Companies Act 1985 (and subsequent amendments) imposes various requirements on limited companies, including Inmarsat, among which are that companies have a board of directors, responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Company and the group and that the financial statements comply with the Companies Act.

The Act also obliges companies to have independent auditors. (Inmarsat’s auditors for the year 2001 were PricewaterhouseCoopers and they were reappointed for the year 2002.)

The guardian of the Act is Companies House, a government agency which comes under the Department of Trade and Industry. Based in Cardiff, Companies House has three main functions305: the incorporation, re-registration and striking-off of companies; the registration of documents that must be filed under company, insolvency and related legislation; the provision of company information to the public.

All limited companies must send a set of accounts and an annual return to Companies House. Failure to deliver documents on time is a criminal offence: directors risk a criminal record, a fine and disqualification. An offending company will incur an automatic financial penalty of up to £1,000 if it is a private company, or £5,000 if it is a public company, if accounts are delivered late. Companies could also be struck off the register if records are not kept up to date.

Section 81 of the Companies Act prohibits a private limited company (unless limited by guarantee and without share capital) from making public offers. Generally, therefore, only a public limited company (plc) can issue a prospectus. (Inmarsat Holdings Limited changed its name to Inmarsat Ventures Limited in June 2000. In March 2001, the Company was re- registered as a public company known as Inmarsat Ventures plc.)

A prospectus must be registered at Companies House on or before the day of its publication. Any supplementary prospectus adding to or correcting the information in the original document must also be delivered immediately to the Registrar. Companies incorporated outside the United Kingdom which offer securities within the UK must also send a copy of their prospectus to the Registrar.

303 para 76, Sagar, 1999. 304 para 5, Report to Parties on the Activities of the Secretariat of the International Mobile Satellite Organization (IMSO). March 2002. 305 www.companieshouse.gov.uk

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If and when Inmarsat makes an IPO, it will need to comply with the provisions of the Financial Services Act 1986, as amended by the Official Listing of Securities (Change of Competent Authority) Regulations 2000, and with the Listing Rules of the Financial Service Authority (FSA). Under these provisions, if securities are to be offered to the public in the UK for the first time before admission, the Listing Rules require that a prospectus be submitted to, and approved by, the FSA and that the prospectus is published.

An offer will be treated as being made to the public if it is made to any section of the public, whether chosen as already being members or debenture holders of the company, or as clients of the person issuing the prospectus, or in any other manner. There are exceptions to the rule, detailed in the Act.

The FSA is an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000, that regulates the financial services industry in the UK.306 It became the single regulator for financial services in the UK on 1 December 2001, when the Financial Services and Markets Act 2000 (FSMA) came into force.

The FSA is the UK competent authority for the admission of securities to the official list. A division of the FSA called the UKLA (the UK Listing Authority) carries out this responsibility. The UKLA reviews and approves all listing particulars, prospectuses and other related documentation which companies put together to have their securities admitted to the official list. The UKLA also approves certain other documents prepared by listed companies, such as acquisition and disposal circulars. The UKLA seeks to ensure that listed companies comply with their ongoing obligations under the listing rules. This includes providing a regular flow of relevant information to the market. The UKLA has the power to impose a financial penalty on a listed company or director where the listing rules have been broken.

The UK Listing Authority requires publicly listed companies to adopt the Principles of Good Governance and Code of Best Practice (the “Combined Code”). See Annex 3 for more details. Although Inmarsat Ventures is not currently required to comply with the Combined Code, it has been adopted wherever appropriate in advance of its IPO and listing on the London Stock Exchange.307

7.2.2.4 British National Space Centre

As a condition precedent to its restructuring, Inmarsat had to acquire from the relevant UK authorities “all requisite licences, consents and approvals”, including approvals required by the Outer Space Act and confirmation that no individual licences were required under the Telecommunications Act 1984 and the Wireless Telegraphy Act 1949.308

Four types of licences are relevant for mobile satellite systems:

(a) Space segment licences;

(b) Satellite Control Centre (SCC) licences;

(c) Feeder link earth station licences; and

(d) User terminal licences.

306 www.fsa.gov.uk 307 p. 28, Inmarsat Ventures Annual Report 2001. 308 Article 3.1(e), Master Transition Agreement.

LN1:#20065849 97 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 98 A space segment licence from the BNSC is required for UK companies to launch and operate a satellite; an SCC facility is required to be located on UK territory and requires a licence to operate; a feeder link earth station licence is required for operating a feeder link station in the UK; and a user licence may be required for user terminals, unless these are exempted through appropriate legislation. 309

BNSC is a voluntary partnership, formed from 10 government departments and research councils, to co-ordinate UK civil space activity.

The Outer Space Act 1986 was enacted to secure compliance with the UK's international obligations under UN Treaties and Conventions covering the use of outer space, including liability for damage caused by space objects and registration of objects launched into outer space. It introduced a licensing regime for space activities carried on by UK nationals and companies. The Act applies to activities whether carried on in the UK or elsewhere. Inmarsat’s space station facilities are licensed by the UK government in accordance with the Outer Space Act.

UK nationals and companies intending to launch or procure the launch of a space object, operate a space object or carry on any other activity in outer space are expected to make themselves familiar with the provisions of the Act and apply for a licence at least six months in advance of carrying on the licensable activity. 310

7.2.2.5 DTI and the Radiocommunications Agency

As a UK company, Inmarsat is subject to the regulatory jurisdiction of the Radiocommunications Agency which an executive agency of the Department of Trade and Industry (DTI).311 The Radiocommunications Agency (RA) is responsible for the management of the non-military radio spectrum in the UK, which involves international representation, commissioning research, allocating spectrum and keeping the radio spectrum clean. Systems using radio need a spectrum licence issued by the Radiocommunications Agency under the Wireless Telegraphy Act 1949.

Inmarsat, like other satellite operators, is required to file all applications for international frequency assignments and associated satellite orbital registrations through the RA/DTI. All access to such orbital locations, including renewals, is subject to the legal and regulatory processes of the UK government, including the RA. Included in their regulations are due diligence requirements to prevent warehousing of orbital slots.312

DTI is responsible for the granting of telecom licences and the Office of Telecommunications (Oftel) for their enforcement once issued.

Under the Telecommunications Act, it is an offence to run a system or provide a service which is not covered by a licence of some description, but many services can be provided within the terms and conditions of existing class licences. An initial fee, intended to reflect the cost of issue, is payable to the government when a licence is granted. In addition, an annual renewal fee is paid to Oftel to cover its work in enforcing licences.

The Telecommunications Act 1984 provides for two main categories of licence to be granted:

309 p. 4, Response to “Radio Spectrum Management Review: A Consultation Paper” [undated]. 310 www.bnsc.gov.uk 311 www.dti.gov.uk/cii/ 312 Comment of Inmarsat before the NTIA, 2000.

LN1:#20065849 98 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 99 • class licences or general authorisations which cover a group or class of users, and cover most of the telecommunication systems run in the UK; 313 and

• individual licences which are issued to individual companies.

In the UK (as in many countries), MSS terminals are exempt from individual licence requirements. A general licence is the only practical means to license MSS terminals and is prescribed by various ERC Decisions and by the EU Licensing Directive.314

Inmarsat land terminals are licence-exempt for use in the bands 1525.0-1559.0 MHz (receive) and 1626.5-1660.5 MHz (transmit). Exemption is on the basis that Inmarsat terminals meet certain equipment standards which ensure adequate protection from interference to other users in the same and adjacent frequency bands. Similar provisions apply to terminals of other MSS systems which operate in the same and other bands. These provisions, and other licence exempt spectrum use, avoid the unnecessary bureaucracy of individual licences for large numbers of terminals. 315

7.2.2.6 Ofcom

The UK plans to create a super communications agency called Ofcom which will regulate the UK communications sector. It is scheduled to be operational by the end of 2003 after enactment of the Communications Bill. Ofcom will combine the existing functions of Oftel, the Broadcasting Standards Commission, Independent Television Commission, the Radio Authority and the Radiocommunications Agency. Hence, Inmarsat will be subject to Ofcom oversight once Ofcom begins operations.

7.2.2.7 IMO

IMSO reports on a regular basis to IMO on performance by the Company in respect of GMDSS, as requested by Parties.316 The IMO Maritime Safety Committee (MSC) reviews and adopts performance standards for Inmarsat ship earth stations against criteria for the provision of mobile satellite communication systems in the GMDSS.317

Although the PSA may be terminated by agreement among the Parties, effectively it is expected to continue until at least such time as IMO confirms that there are alternative satellite systems providing GMDSS services. This arrangement is unusual in that IMO, though not a party to the PSA, is named as the entity that ultimately decides whether its primary purpose has been fulfilled.318

313 The Duopoly Review led to extending the use of “class” licences, or “general authorisations”, which cover broad categories of activity carried out by a wide range of organisations, obviating the need for an individual licence. DTI published the Duopoly Review white paper Competition and Choice: Telecommunications Policy for the 1990s in 1991. Inter alia, the Duopoly Review opened the UK market to other carriers and put an end to the policy which had limited the provision of fixed telecom services to BT and Mercury and of mobile communications to BT Cellnet and Vodafone. It also allowed international simple resale to destinations with equivalent freedom to the UK. 314 p. 8, Response to “Radio Spectrum Management Review: A Consultation Paper” [undated]. 315 p. 4, Response to “Radio Spectrum Management Review: A Consultation Paper” [undated]. 316 para 7.1, Report to Parties on the Activities of the Secretariat of the International Mobile Satellite Organization (IMSO). March 2002. 317 para 8.3.2, IMSO Assembly Report, 19 Sept 2002. 318 para 32, Sagar, 2002. The equivalent Intelsat and Eutelsat agreements do not have such a requirement.

LN1:#20065849 99 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 100 7.2.2.8 ICAO

Following the signature of a revised Agreement of Co-operation with the International Civil Aviation Organisation in September 2000, IMSO has worked with the Company to ensure that the aeronautical services comply fully with ICAO Standards and Recommended Practices (SARPs). Aeronautical services thus receive the same effective level of oversight as the maritime safety services and periodic reports are made to the relevant bodies of ICAO. 319

7.2.2.9 ITU

A condition precedent of the restructuring of Inmarsat was receipt of a written assurance from the relevant regulatory authority in the UK, in consultation with the ITU, that the transactions would have no material effect on the status of its orbital slots.

Although licences are awarded by the UK for UK MSS networks, assignments of frequencies are agreed through international frequency co-ordination involving non-UK networks. Operational parameters are limited to those agreed in the frequency co-ordination. As Inmarsat provides a global service, it is therefore necessary (highly desirable) that international satellite allocations are also global and that national allocations conform to the ITU allocations.320 Mandatory harmonised technical standards are not required.

Prior to privatisation, Inmarsat was one of a few select satellite operators which had a special status at the ITU as Intergovernmental Satellite Organisations (ISOs). Since privation, Inmarsat has status at ITU meetings as a Recognised Operating Agency (ROA).

IMSO has had Administrative Arrangements with the ITU since September 2001 and procedures have been initiated for IMSO to become a sectoral member of the ITU Convention.321

7.2.2.10 European Commission

One of the conditions precedent which had to be satisfied before Inmarsat could be privatised was that the European Commission had to give its approval to the way in which Inmarsat was privatised, to ensure that Inmarsat did not fall afoul of the anti-competitive provisions of Articles 85 and 86 of the EC Treaty. The IGO had to receive from the Commission “a formal decision or administrative letter indicating that Article 85(1) and Article 86 of the Treaty are not applicable to the Agreement and the Restructuring Agreements.”322

The European Commission duly declared that the restructuring agreements did not to any appreciable extent affect competition within the Common Market, although one issue which could cause the Commission to reconsider the matter would be if the Company’s intention to carry out an initial IPO did not take place within three years.323

Inmarsat, like the UK itself, must also comply with the EC’s new regulatory framework for electronic communications networks and services which is to be applied in all Member States from 25 July 2003.324 All Member States must adapt national legislation implementing the

319 para 8.2, IMSO Assembly Report. 19 September 2002. 320 p. 5, Response to “Radio Spectrum Management Review: A Consultation Paper” [undated]. 321 para 7.3, Report to Parties on the Activities of the Secretariat of the International Mobile Satellite Organization (IMSO). March 2002. 322 Article 3.1(d), Master Transition Agreement. 323 para 89, Sagar, 1999. 324 The new regulatory framework comprises principally five directives, namely the Framework Directive, Access and Interconnection Directive, Authorisation Directive, Universal Service Directive, Data Protection Directive.

LN1:#20065849 100 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 101 directives by 24 July 2003 with the exception of the Data Protection directive, for which the date is 31 October 2003.

In addition, Inmarsat, its service providers and manufacturers are bound by other legislation, including:

• Decision 1215/2000/EC of 16 May 2000 to prolong the S-PCS Decision until 31 December 2003;

• Directive 1999/5/EC of the European Parliament and of the Council of 9 March 1999 on radio equipment and telecommunications terminal equipment and the mutual recognition of their conformity. The R&TTE Directive contains provisions related to the free circulation and the putting into service of radio communications and telecommunications terminal equipment in the EU;

• Directive 97/13/EC of 10 April 1997: the Licensing Directive contains provisions relating to the authorisation of satellite networks and services in the EU;

• Decision 710/97/EC of 24 March 1997: the S-PCS Decision established a co-ordinated approach in the field of satellite personal communications services in the EU; and

• Commission Directive 94/46/EC of 13 October 1994: the Satellite Directive extended the liberalisation of telecommunications to the satellite communications sector (amending Directive 88/301/EEC and Directive 90/388/EEC in particular with regard to satellite communications).

7.2.2.11 World Trade Organisation

The WTO does not directly regulate Inmarsat, but as the UK is a member of the WTO and as the UK was one of the countries to adhere to the WTO Basic Telecommunications Agreement, its provisions do have some effect on Inmarsat and the regulatory environment in which it operates. The United Kingdom has a schedule of commitments under the Basic Telecom Agreement that includes non-discriminatory access to its satellite markets. Neither the United Kingdom nor any other nation provides Inmarsat any preferential treatment through privileges or immunities.325

Under the Basic Telecommunications Agreement, signed on 15 February 1997, 69 members agreed to open their basic telecoms markets to competition and to extend the General Agreement for Trade in Services (GATS) to basic telecommunication services. The agreement, which came into force on 5 February 1998, provided a framework for the gradual liberalisation of market access and established a framework of basic regulatory principles (such as measures to prevent anti-competitive behaviour and non-discriminatory and timely provision of interconnection at cost-oriented rates) to which the majority of countries committed themselves. Virtually all of the countries that signed the Basic Telecom Agreement also signed the Reference Paper on regulatory principles, including establishment of a regulatory authority independent of any operator.

Further, 75 per cent of those countries included market access commitments for satellite services. As of December 1998, the WTO reported that 80 countries have scheduled basic telecommunications commitments.

325 Comment of Inmarsat before the NTIA, 2000.

LN1:#20065849 101 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 102 7.2.2.12 Federal Communications Commission

The FCC does not directly regulate Inmarsat (especially now that Inmarsat is a UK-based company) but its regulatory impact on Inmarsat over the years has been significant.

On 17 March 2000, the US Congress enacted the Open-market Reorganization for the Betterment of International Telecommunications Act (the ORBIT Act), the purpose of which was to promote a competitive market for satellite communications through privatisation of the ISOs, Inmarsat and Intelsat.

The ORBIT Act prohibits exclusivity arrangements. Specifically, the ORBIT Act states that “[n]o satellite operator shall acquire or enjoy the exclusive right of handling telecommunications to or from the United States ... and any other country or territory by reason of any concession, contract, understanding, or working arrangement to which the satellite operator ... [is a party].”

The ORBIT Act required the FCC to determine after 1 April 2000, whether Inmarsat has “been privatised in a manner that will harm competition in the telecommunications markets of the United States.” The ORBIT Act also required the President and the FCC to make annual reports to the Committees of Commerce and International Relations of the House of Representatives and the Committees on Commerce, Science, and Transportation and Foreign Relations of the Senate regarding the privatisation of Intelsat and Inmarsat.

In order to meet the relevant ORBIT Act criteria, Inmarsat was nominally required to list its shares for trading on one or more stock exchanges with transparent and effective securities regulation, and to “substantially dilute” the aggregate ownership of Inmarsat by former Signatories.326 Inmarsat sought competitive bids from investment bankers to assist it in the implementation of its IPO. Inmarsat Ventures had plans to float 25 per cent of its shares to the public and expected to list such shares on the Nasdaq or New York Stock Exchange, in addition to the London Stock Exchange.327

In October 2001, the FCC determined that Inmarsat had been privatised in a manner consistent with the ORBIT Act.328 Consequently, the FCC authorised earth stations to provide mobile satellite service in the United States using Inmarsat.329 The authorisations were conditioned upon Inmarsat compliance with the ORBIT Act requirement that it conduct an IPO.

The ORBIT Act required Inmarsat to conduct its IPO no later than October 2000. The Act permitted the FCC to extend this deadline to no later than December 2001. In October 2000, the FCC granted an Inmarsat request for a six-month extension of the IPO deadline to July 2001. In April 2001, Inmarsat filed for a second extension of its IPO deadline to December 2001 based on unfavourable market conditions. In June 2001, the FCC granted this request. In November 2001, Congress agreed to further extend Inmarsat’s IPO deadline to December 2002. Congress also gave the Commission discretion to further extend this deadline “no later than June 2003”.330 The FCC has now granted an extension to 30 June 2003 in an Order adopted on 17 December 2002 and released on 19 December 2002.

Inmarsat Ventures still plans to become a publicly quoted company. According to its Annual Report for 2001 (p. 3), the board of directors agreed in 2000 to follow the advice of its

326 Comment of Inmarsat before the NTIA, 2000. See also ORBIT § 621(2); § 621(5)(B). 327 Comment of Inmarsat before the NTIA, 2000. 328 FCC press release, 9 Oct 2001. 329 In its Order, the FCC granted Comsat Corporation; Stratos Mobile Networks, LLC; SITA Information Computing Canada, Inc.; Honeywell, Inc.; Marisat Communications Network, Inc.; and Deere & Company permanent authority to use Inmarsat for communications services to, from or within the United States. 330 FCC Report to Congress as required by the ORBIT Act. 14 June 2002.

LN1:#20065849 102 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 103 investment bank to postpone the IPO. “Our investment bankers continue to review the stock market conditions carefully and we will look to undertake an IPO at the appropriate time.”

On the subject of the delayed IPO, an Inmarsat spokesman said recently that the Company “remains in a state of readiness.” The IPO will happen “when market conditions are right and when our advisers give us the green light.”331 However, it is understood that the Company may now seek alternative ways of raising finance.332

7.2.2.13 At the national level

One of the conditions precedent to be satisfied before Inmarsat could be restructured was the receipt by the IGO of confirmation that the implementation of the Restructuring Agreements would have no material effect on the status of each LESO in terms of the local regulatory and licensing regime, that the implementation would not alter or affect the existing licensing or other regulatory obligations in relation to the use of mobile earth station terminals. The IGO was also required to determine whether the restructuring would result in a new requirement for a licence as an operator of satellites in Inmarsat’s top 10 markets.333

Inmarsat, its service provides and users are obliged to comply with national licensing and regulatory requirements in the countries in which they operate. Under ITU RR 2020, each country has sovereignty over the use of radio frequency spectrum in their country.334 Generally, this has affected SPs and MES users, to a greater or lesser extent, but some countries have required satellite operators whose satellites are accessed by SPs or users in those countries to have a presence (a subsidiary) in the country which in turn must also be licensed. In addition to the licensing requirements re use of the RF spectrum, companies such as SPs must, as in the UK, be authorised and/or meet certain requirements for carrying on a business. Licensing and regulatory requirements affecting the use of the RF spectrum vary greatly, from outright prohibition to high licence fees to nominal or no fees at all.

7.2.3 NECESSITY OF AN INDEPENDENT MONITORING BODY

When Inmarsat was privatised, it was deemed by the international community that some oversight was necessary, as reflected in the establishment of IMSO and the Public Services Agreement. The need for an independent monitoring body (in this case, IMSO) is still apparent.335

In reality, Inmarsat is subject to oversight by various regulatory bodies, notably those referenced in more detail in the previous section.

331 “Inmarsat Ventures says posts stable EBITDA in 2001” by Anne Young, Total Telecom, 5 March 2002. 332 para 9, Satellite Services (Inmarsat and COSPAS-SARSAT). Analysis and assessment of the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO). COMSAR 7/5/2. 8 November 2002. 333 Article 3.1(o), (p), (q), Master Transition Agreement. 334 ITU Radio Regulation 2020(1) states that: “No transmitting station may be established or operated by a private person or by any enterprise without a licence issued in an appropriate form and in conformity with the provisions of these Regulations by the government of the country to which the station in question is subject.” 335 See the Text of Proposed Amendments to the Convention on the International Mobile Satellite Organization by the Party of Denmark: “There is a need to secure continuity of the public interests through intergovernmental oversight.”

LN1:#20065849 103 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 104 There is, of course, on-going oversight by IMSO. Parties to the IMSO Convention have requested the Director of IMSO to report on an annual basis to IMO on the performance of Inmarsat Ltd in regard to the provision of GMDSS services by the Company. 336

Inmarsat Ltd could terminate the Public Services Agreement with IMSO under Clause 18 (c), putting itself on an equal and competitive footing with other satellite system operators: as a result, international oversight of public service obligations including GMDSS would cease to exist.337 However, Clause 18(c) has a crucial pre-condition, as noted in section 7.3.9 below, i.e., that Inmarsat’s unilateral termination of the PSA could only occur if the SOLAS Convention recognised other satellite systems as fulfilling GMDSS requirements.

Within the Inmarsat Ventures structure itself, there are three separate committees which provide some independence at Board level. Under Article 161 of its Articles of Association, Inmarsat Ventures is required to establish committees in relation to the nomination of Directors, the remuneration and emoluments to be given to Directors and executive officers of the Company, and the auditing of the Company’s books and records of account. These are the Nominations Committee, Remuneration Committee and Audit Committee respectively.

The Articles of Association also impose certain obligations on Directors to ensure their independence and fiduciary responsibilities, e.g., declaring any material interests which they may have in relation to the Company’s business, neither voting nor participating in discussions in which they have a material interest.

The Articles of Association of Inmarsat Ltd are somewhat different in regard to Directors. Under Article 35, and subject to the provisions of the Companies Acts and Article 44 (concerning the circumstances warranting recusal), and provided that he has disclosed to the Board the nature and extent of any material interest, a Director may be a party to any transaction or arrangement with the Company. He is not accountable to the Company for any benefit which he derives from any such transaction or arrangement. Under Article 44, a Director is not permitted to vote at a meeting of the Board on any resolution concerning a matter in which he has an interest.

7.2.4 PUBLIC SECTOR REQUIREMENTS IMPOSED ON THE PRIVATE ENTITY

7.2.4.1 The Public Services Agreement

As part of the privatisation of Inmarsat, the Assembly decided to put in place a Public Services Agreement between IMSO, Inmarsat Holdings (Inmarsat Ventures) and the Company (Inmarsat Ltd). According to the PSA, IMSO, Holdings and the Company “identified certain public service obligations, as defined in this Agreement, in which third parties have an interest, and which were hitherto vested in the Organisation and now form the subject of this Agreement. These public service obligations implement the basic principles set forth in Article 3 of the Convention.”

The Organisation, Holdings and the Company agreed that the public service obligations must be maintained and that the agreement of the Company in assuming such obligations was a prerequisite to the agreement of the Organisation in sanctioning the restructuring and that the performance of the obligations by the Company is of continuing material benefit to the Organisation and its Parties.

336 Information on the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO) to the IMO Sub-Committee on Radiocommunications and Search and Rescue. September 2000. 337 para 10, Proposed Amendments to the Convention on the International Mobile Satellite Organization. Submission by IMSO. Maritime Safety Committee. MSC 75/11/4. xx March 2002.

LN1:#20065849 104 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 105 In accordance with Article 4 of the IMSO Convention, the Agreement sets out the rights of the Organisation to oversee and ensure the observance by the Company of its public service obligations, principally “to ensure the continuity of maritime satellite distress and safety communications services for the GMDSS”.338

The Agreement also recorded the intention of Inmarsat Ventures to pursue a listing of its shares on one or more recognised investment exchanges within approximately two years from the date of this Agreement. As of February 2003 and as mentioned above, this has yet to happen, although it is still expected when the market improves.339

The PSA requires IMSO to provide IMO with regular reports on Inmarsat’s performance under the terms of the agreement. Inmarsat, via IMSO, is also expected to “consult regularly with the IMO in respect of any proposed change by the Company in the specification of standards, services and systems that relates to the Company’s provisions of the capabilities specified in Clause 2.1, including any proposed discontinuation of a service, before the implementation of the proposed change, and [to] take into account any recommendation and decisions of the IMO.”340

The PSA is primarily oriented towards maritime safety services but does make reference to other services. Article 3 says, “The Company shall take into account the relevant international standards, regulations, resolutions, procedures and recommendations of the International Maritime Organization and the International Civil Aviation Organization, and shall observe the relevant provisions of the Constitution and the Convention of the International Telecommunication Union and the regulations made thereunder.” Moreover, Article 2.4 says “The Company shall seek to serve all areas where there is a need for mobile satellite communications, giving due consideration to the rural and the remote areas of developing countries.”

The PSA establishes a Public Services Committee comprising the Chairmen of the Boards of Holdings and the Company, the Chief Executive Officer of the Company, one other non- executive Director of the Company and the Director of the Secretariat of the Organization or his or her representative.341

Neither Inmarsat Ventures nor Inmarsat Ltd may assign any of their rights or obligations under the Agreement in whole or in part without the prior approval in writing of the Organisation.342

Inmarsat Ventures’ Articles of Association captures its public service obligations (or basic principles) as follows:

“The Board shall have regard to the following basic principles:

(a) ensuring the continued provision of global maritime distress and safety satellite communications services, in particular those which are specified in the International Convention for the Safety of Life at Sea, 1974, as amended from time to time, and the Radio Regulations annexed to the International Telecommunication Constitution and Convention, as amended from time to time, relative to the GMDSS;

338 Article 2.1.1. PSA. 339 See section 6.2.2.12 on the FCC for more details. 340 Article 2.1.7. PSA. E-mail from Jerzy Vonau, IMSO Director, 25 Feb 2003: “After privatisation, Inmarsat Ltd has no right to approach intergovernmental organizations directly except through IMSO in respect of the five public service obligations, or via the UK Government, in respect of commercial activities of the Company.” 341 Article 4.1, PSA. 342 Article 8.1, PSA.

LN1:#20065849 105 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 106 (b) providing services without discrimination on the basis of nationality. Notwithstanding the foregoing, the Company shall have the right to offer different charges for the same service in defined geographical regions in which end-user calls or messages originate or terminate and which are technically verifiable;

(c) acting exclusively for peaceful purposes, taking into account the past practices of the Organization and the practice of the Company;

(d) seeking to serve all areas where there is a need for mobile satellite communications, giving due consideration to the rural and the remote areas of developing countries; and

(e) operating in a manner consistent with fair competition, subject to applicable laws and regulations (together the Public Service Obligations).”343

7.2.4.2 Supporting the public service obligations: practical examples

In support of its public service obligations, Inmarsat Ltd provides maritime distress and safety services for the GMDSS at either no cost or a special rate as the most important public service obligation. 344 Inmarsat cites as another example of its support the launch of a safety database for the maritime community, specifically for use by Maritime Rescue Co-ordination Centres (MRCCs). “The database provides MRCCs with immediate round-the-clock access to all the information needed to assist vessels in distress (including the ship’s name and call sign, nationality and 24-hour contact number), thereby cutting life-saving minutes off emergency rescue operations.”345

Inmarsat also supports Télécoms Sans Frontières (TSF), a French non-governmental organisation which provides rapid-response telecommunication facilities for relief operations following sudden disasters. 346

IMSO has taken an initiative to support international efforts to combat piracy and armed robbery against ships. It has requested Inmarsat Ltd. to review certain options for enhancing Inmarsat communication capabilities to provide more specific and direct support for vessels suffering attack by pirates.347 This request has apparently been well received both within Inmarsat as well as IMO.

Inmarsat Ltd has also recently co-operated with the ITU to help promote rural telecommunication and support emergency communications in least developed countries. Inmarsat made a € 100,000 financial contribution in early January 2002 towards the purchase of 15 Global Area Network (GAN) satellite terminals in the least developed countries (LDCs). ITU will select the beneficiary countries and will contribute an amount not less than the value

343 Article 154, Articles of Association, Inmarsat Ventures plc. The basic principles are also contained in Article 7 of the Memorandum of Association of Inmarsat Ltd and Article 8 of the MoA of Inmarsat Ventures. Article 7 of its MoA obliges Inmarsat Ltd to have regard to the basic principles in carrying out its objects, as listed in Article 3, the first purpose of which is “To provide and support global, regional and domestic satellite services, including, without limitation, maritime, aeronautical, land based communications services, radiodetermination (including radionavigation) and distress and safety services and all related and associated infrastructure wherever located”. Under Article 3.19, the Company is entitled “To sell, dispose of or transfer the business, property and undertaking of the Company or any asset or part thereof for any consideration”. 344 para 4.1, Information on the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO) to the IMO Sub-Committee on Radiocommunications and Search and Rescue. September 2000. 345 p. 16, Inmarsat Ventures Annual Report 2001. 346 p. 16, Inmarsat Ventures Annual Report 2001. 347 para 8.2.1, IMSO Assembly Report, 19 Sept 2002.

LN1:#20065849 106 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 107 of the donated Inmarsat GAN terminals. This amount will be used to pay for airtime and for other expenses associated with the execution of the project.348

7.2.5 OWNERSHIP OF ASSETS

The transition from ISO to limited company represented a transfer of assets and liabilities under common control and was accounted for as a group reconstruction applying the principles of merger accounting.349

The assets and interests in Inmarsat the IGO were transferred to Inmarsat Ltd and the sole shareholder of Inmarsat Ltd was and is Inmarsat Ventures (ex-Inmarsat Holdings). Upon the privatisation of Inmarsat the IGO, each Signatory was entitled to ordinary shares in Inmarsat Holdings in accordance with the last redetermination of investment shares pursuant to the Operating Agreement prior to completion.

Following privatisation, Inmarsat Ventures acquired several companies, some of which it has since wound up. One remaining subsidiary is Invsat Ltd which provides integrated telecommunications systems and services, including satellite systems, radio systems and VSAT (very small aperture terminal) satellite services to oil and gas, maritime, government and emergency services customers. A second is Rydex Corporation Ltd which develops and provides wireless electronic mail, ship/shore messaging and automated data communications systems to the maritime industry.

Inmarsat Ventures has a board of 13 directors, comprising two executive directors and 11 non-executive directors, eight of whom are independent. The three non-independent, non- executive directors are employed directly or indirectly by distributors of Inmarsat services.350 The board meets regularly throughout the year. Since the appointment of the first directors in April 1999, non-executive directors have been appointed initially for three years and all non- executive directors may not, unless exceptionally agreed by the board, remain in office for a period longer than six years, or two terms in office, whichever is the shorter. All directors are required by the company’s Articles of Association to be elected by shareholders at the first general meeting after their appointment. At least one third of the directors must seek re- election by the shareholders at each annual general meeting.

At an extraordinary general meeting held in March 2001, shareholders approved the re- registration of the company as a public limited company and a 10:1 share split of the company’s shares. As at 1 March 2002, there were 100,000,010 ordinary shares of 10 pence each in issue. In addition, one special rights non-voting redeemable preference share of £1.00 is held by IMSO.

At year end 2001, the company’s register of substantial interests showed the following interests of 3 per cent or more in the company’s shares:

Number of % ordinary shares

Telenor Satellite Services AS Norway 15,000,000 15.0

348 Item on the ITU web site. Geneva, 6 January 2003. 349 p. 55, Inmarsat Ventures Annual Report 2001. Merger accounting allows the transfer to be carried out in a manner where there is no good will to write down, as opposed to acquisition accounting. 350 Under Article 139 of its Articles of Association, the number of directors must not be less than nine and not more than 13; independent non-executive directors must constitute a majority of non-executive directors; and at least one director must be, at the time of his appointment or re-appointment, from a developing country. A director who retires at an annual general meeting may be re-appointed (Article 147).

LN1:#20065849 107 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 108

COMSAT Corporation US 14,007,920 14.0

British Telecommunications plc UK 7,857,950 7.9

KDDI Corporation Japan 7,572,790 7.6

Xantic BV The Netherlands 5,862,300 5.9

Atlas Telecommunications SA France 5,096,570 5.1

Hellenic Telecommunications Greece 4,672,690 4.7 Organisation SA

Deutsche Telekom AG Germany 4,280,620 4.3

Morsviazsputnik Russia 3,695,060 3.7

The maximum permitted shareholding in the company is 15 per cent of the issued share capital.351 During 2001, Telenor acquired Comsat Mobile352, both among the top five shareholders, as apparent from the above table, however, that has not affected the rule re a maximum 15 per cent of shares held by a single shareholder.353

With regard to the ownership of other parts of the Inmarsat system infrastructure, the Land Earth Stations are owned and operated by service providers (who for the most part are also shareholders), while individual mobile earth stations are owned or leased by individual users.

Since privatisation, there has been increasing consolidation in the traditional mobile satellite distributor market so that Inmarsat now has five major distributors who account for approximately 80 per cent of the core revenues. Inmarsat believes this to be beneficial to the growth and expansion of the mobile satellite business.354

7.2.6 SECURITY STRUCTURES

Inmarsat has no security structure comparable to the Galileo Security Board/Authority. However, it does apply security measures to protect its assets, business and employees. More particularly, it has put in place a risk management system which is discussed below in section 7.3.6.

351 The limitation on shareholding is specified in Articles 33-44 of the Articles of Association of Inmarsat Ventures. 352 “Telenor acquires COMSAT Mobile Communications and forms Telenor Satellite Services”. Telenor Press Release. 16 Jan 2002. 353 Telenor acquired the Comsat’s mobile satellite business not its shareholding so there was no change in the number of shares held. Comsat sold Telenor some of its shares a few years ago and Telenor now holds 14.95% and Comsat 13.96%. 354 pp. 4-5, Inmarsat Ventures Annual Report 2001.

LN1:#20065849 108 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 109 7.3 AGREEMENT BETWEEN THE PUBLIC AND THE PRIVATE ENTITY

7.3.1 AVAILABILITY PAYMENTS AND SHARING OF REVENUES

There are no availability payments made between IMSO and Inmarsat, nor is there any sharing of revenues between the two. As discussed above, although IMSO has a Special Share in Inmarsat Ventures, this does not entitle it to any profits. However, as also mentioned above, Inmarsat does fund IMSO.

Inmarsat shares its profits with its shareholders in the form of dividends like any other company, although no dividends were paid in 2001, the latest year for which results are publicly available.355 It also operates an employee share ownership scheme.

7.3.2 RESPONSIBILITY FOR SYSTEM EVOLUTION

Inmarsat is responsible for its own system evolution. A new generation of satellites, Inmarsat 4, will mark a new stage in that evolution. The Inmarsat Board decided on the procurement of a new space segment in May 2000 and awarded a contract to Astrium to build three satellites (two operational and one spare). Inmarsat has said it is on schedule with the planned launch of the Inmarsat-4 satellite system, with services scheduled to be rolled out in 2005.

The new satellites will support the company's next generation of services, called the broadband global area network (B-GAN). The company will offer data rates of up to 432 kilobits per second and expects to be compatible with UMTS. The company launched a regional B-GAN service at the end of 2002, offering data rates of up to 144 kbit/s with GPRS compatibility.356

The B-GAN will provide higher speed Internet, video-on-demand, video-conferencing, fax, e- mail and other advanced multi-media applications. The whole project, including the satellites, will cost about $1.6 billion.357

7.3.3 SERVICE GUARANTEES

Inmarsat does not, as a matter of course, offer service guarantees. However, Inmarsat does commit to its LESOs to exercise its best endeavours in respect of its current demand assigned services to achieve target and not-to-exceed figures for grade of service, space segment availability and network availability.

The PSA does require Inmarsat to provide maritime safety services and some other services to a more limited extent. See section 7.3.4.2 for more details.

7.3.4 PERFORMANCE MEASUREMENTS

Performance can be measured in a variety of ways. Shareholders measure performance by the growth in revenues, profits, dividends, market share. Customers measure performance by quality, reliability and availability of services. Management measure staff performance in a

355 p. 25, Inmarsat Ventures Annual Report 2001. 356 “Inmarsat Ventures says posts stable EBITDA in 2001” by Anne Young, Total Telecom, 5 March 2002. 357 “Inmarsat unveils the world’s fastest commercial portable wireless data service”. Inmarsat press release. 18 Nov 2002.

LN1:#20065849 109 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 110 variety of ways and, if they are lucky, staff can also measure management performance. Management performance is measured by the shareholders and board of directors.

7.3.4.1 Financial performance

The most recent, publicly available financial performance figures are those for the year ending 2001, which was Inmarsat Ventures’ second full year of operation as a private company. The profit for the year after taxation and minority interests amounted to US$65.6 million (2000: US$62.6 million).358

Profit on ordinary activities before taxation was US$63.3 million for the year 2001 compared to US$92.8 million for the year 2000. The reduction in profits was due to a number of exceptional expenses. Excluding these exceptional items, according to the Annual Report, profit before taxation for the year 2001 would have been US$116.8 million, an increase of 25.9 per cent on 2000.359

The latest Annual Report (that for 2001) summarises Inmarsat Ventures’ profit and loss account and balance sheet for the years before and after privatisation as follows:

Profit and Loss 1997 1998 1999 2000 2001

(US $ millions)

Revenues 378 399 401 417 442

Profit before tax and provision 127 123 112 93 63 for diminution

in value of investment

Profit/(loss) for the financial year 127 123 (62) 63 66

Operating cash flow 317 405 338 296 256

Balance Sheet

Net funds/(debt) at the year end 35 61 131 190 (62)

Tangible Fixed Assets 1,116 1,006 857 845 963

Total assets less liabilities 977 848 639 701 766

The consolidated financial statements for the periods after privatisation are not directly comparable with those prior to privatisation because the organisation’s employees were paid levels of remuneration that reflected their status as exempt from UK income taxes, and the entity itself was exempt from UK taxation.360

358 p. 25, Inmarsat Ventures Annual Report 2001. 359 p. 19, Inmarsat Ventures Annual Report 2001. The reason profits after tax were higher than those before tax was because Inmarsat received a tax credit in 2001 as explained in note 10 to its accounts. "In 2001 the value for capital allowances purposes of satellite assets transferred on Transition was agreed with the Inland Revenue and as a result we have recognised a significant tax credit arising from the adoption of these revised values for the year ended December 31, 2001." 360 p. 67, Inmarsat Ventures Annual Report 2001.

LN1:#20065849 110 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 111 The majority of the space segment revenue of the group is derived from sales to Land Earth Station Operators who operate in accordance with the terms and conditions of the Land Earth Station Operator Agreement.

7.3.4.2 Operational performance

IMSO provides IMO with an annual analysis and assessment of the performance by Inmarsat Ltd of the company’s obligations for the provision of maritime services within the GMDSS. The most recent report covers the year to 31 October 2002.361

Previously, IMSO observed that, although there is no formal legal requirement on Inmarsat Ltd to provide in-orbit spare satellites, there is a clear obligation on the company to have a policy in place for the restoration of GMDSS services in the event of the catastrophic failure of one of the operational prime satellites and indeed Inmarsat Ltd has established such policies. In the past, Inmarsat was able to provide such restoration through the use of former- generation spare satellites located in orbit close to the operational primes. However, at present, Inmarsat Ltd is using some former-generation satellites for commercial purposes and has moved these satellites away from their former locations close to the primes. IMSO said that this could pose difficulties or delays in the restoration of full GMDSS services if a prime satellite were to fail. 362

The availability of all distress alerting and other GMDSS components within the Inmarsat Ltd system during the 12-month period from October 2001 to September 2002 is shown in the following table:

AOR-E IOR POR AOR-W

Space Segment 99.9992% 100.0000% 100.0000% 99.9994%

Inmarsat-A 99.9897% 99.9918% 99.9990% 99.9933%

Inmarsat-B/M 99.9983% 99.9996% 100.0000% 99.9990%

Inmarsat-C 99.9979% 100.0000% 100.0000% 99.9987%

Inmarsat-E 100.0000% 100.0000% 100.0000% 100.0000%

The definition of availability and methods of calculation are based on the approach adopted in section 3.5 of CCIR Report 918 (MOD F) “Availability of Communications Circuits in the Maritime Mobile Satellite Service”, dated 15 December 1989.

The rate of availability of Inmarsat services has been very high, better than 99.9 per cent, i.e., outages when the services have not been available have been lower than 0.01 per cent. However, IMSO’s analysis of the figures for the availability of Inmarsat services in each ocean region highlights the fact that annual total figures for availability can disguise single periods of non-availability that are longer than desirable for a primary distress alerting system. IMSO has

361 “Satellite Services (Inmarsat and Cospas-Sarsat): Analysis and Assessment of the GMDSS Performance of Inmarsat Ltd”. Seventh Session of the IMO Sub-Committee on Radiocommunications and Search and Rescue. November 2002. 362 Para 4.6, Information on the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO) to the IMO Sub-Committee on Radiocommunications and Search and Rescue. September 2000.

LN1:#20065849 111 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 112 drawn the company’s attention to the need to reduce the length of individual periods of failure as far as it is possible. 363

The figures for the space segment show planned satellite outages for maintenance of 4 minutes in the Atlantic Ocean Region-East (AOR-E) in January 2002 and 3 minutes in the Atlantic Ocean Region-West (AOR-W) in August 2002. They were not regarded as significant in terms of GMDSS operations. There were no satellite outages in the Indian Ocean Region (IOR) or Pacific Ocean Region (POR) during the period.

The service related figures indicate there have been no service failures lasting longer than 7 minutes during the period covered by this report, with the exception of Inmarsat-A service, which has been subject to difficulties in the Network Control Stations (NCSs) in all ocean regions during September 2002. These problems resulted in downtime for Inmarsat-A of up to 44 minutes in the AOR-E during September 2002. The problems have been resolved and are not expected to recur. The universal figure of 100 per cent availability for Inmarsat-E is a direct result of the way the system has been engineered to duplicate every critical function. Other shorter periods of service non-availability were caused by minor equipment failures in the network control stations. None of these was regarded as significant in terms of GMDSS operations.364

At present, 64 Inmarsat-A, 77 Inmarsat-B/M, 51 Inmarsat-C and 8 Inmarsat-E land earth stations (LESs), located at various sites world-wide, provide the essential terrestrial gateways for GMDSS-related communications for distress alerting, rescue co-ordination communications and the promulgation of Maritime Safety Information (MSI) using basic telex, telephony and message transfer services.365

During the 12 month period to September 2002, the number of Inmarsat-C distress alerts received totalled 1935, compared to the previous year total of 1992 distress alerts and 2398 for the year before that. 366

The IMSO Director’s assessment is that, during this period, Inmarsat Ltd has continued to provide fully operational maritime mobile satellite distress and safety communication services for the GMDSS and to fulfil the company’s public service obligation as stated in paragraph 2.1.2 of the PSA.367

7.3.4.3 Performance of public service obligations

The Company has an established policy in regard to each of its public service obligations and these matters are reviewed at each meeting of the PSC. In its report to its Assembly, IMSO made the following observations:

363 Para 4.5, Information on the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO) to the IMO Sub-Committee on Radiocommunications and Search and Rescue. September 2000. 364 para 3.1, Satellite Services (Inmarsat and COSPAS-SARSAT). Analysis and assessment of the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO). COMSAR 7/5/2. 8 November 2002. 365 para 3.2, Satellite Services (Inmarsat and COSPAS-SARSAT). Analysis and assessment of the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO). COMSAR 7/5/2. 8 November 2002. 366 para 3.5, Satellite Services (Inmarsat and COSPAS-SARSAT). Analysis and assessment of the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO). COMSAR 7/5/2. 8 November 2002. 367 para 11, Satellite Services (Inmarsat and COSPAS-SARSAT). Analysis and assessment of the GMDSS performance of Inmarsat Ltd. Note by the International Mobile Satellite Organization (IMSO). COMSAR 7/5/2. 8 November 2002.

LN1:#20065849 112 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 113 (a) The policy of operating in a manner that does not discriminate on the basis of nationality is embodied in the Land Earth Station Operator Agreement. The Director was not aware of any complaints in this respect in relation to the Company’s activities.

(b) The Director was not aware of any complaints re the obligation to act exclusively for peaceful purposes.

(c) Regarding the obligation to seek to serve all areas where there is a need for mobile satellite communications, giving due consideration to the rural and remote areas of developing countries, the Director has requested, and now receives, information from the Company as to the efforts being made in this regard. Whilst the Company does not have the resources to be active in every rural or remote region of the world, the Director is satisfied that the current programme of visits, conferences and seminars undertaken by Inmarsat Ltd and its partners provides a realistic and practical response to this public service obligation.

(d) The Company has established a Competition Law Compliance Policy as well as guidelines for its employees to give effect to the requirements of competition principles. The Director was not aware of any complaints.

(e) To date, IMSO has not been able to detect any reduction or deterioration in the level and quality of the provision of GMDSS services by Inmarsat Ltd compared with the situation prior to privatisation. All basic principles (public service obligations) continue to be observed, or due consideration has been given by the Company. Aeronautical services continue to be provided in accordance with ICAO SARPS. The Director concluded that the principles under which the process of restructuring Inmarsat took place continue to be observed and implemented on both a formal and working level. 368

7.3.5 THIRD PARTY LIABILITIES

Until Inmarsat was privatised, Signatories had unlimited liability, as mentioned in section 7.1.1.1. Thus, when Inmarsat was restructured, Signatories wanted Inmarsat (shareholders especially) to have limited liability. This is now the case. Under Article 4 of the Inmarsat Ltd Memorandum of Association “The liability of the members is limited to the paid-up value of their shares.” A similar provision exists under Article 5 of the Inmarsat Ventures MoA.

Under Article 238 of the Articles of Association of Inmarsat Ventures, directors are indemnified against all costs, charges, losses, expenses and liabilities incurred in the execution or discharge of their duties.

Inmarsat has a full range of insurance policies, including those to cover third party legal liability arising from network interruptions.369

Inmarsat developed practices for handling liability issues, taking into account the provisions in the Outer Space Treaty and the Liability Convention as they relate to the space environment and the problem of space debris.370 The Outer Space Act requires Inmarsat to take out a policy that covers in-orbit events such as satellite collisions in space, remote though that possibility might be.

368 Paras 8.1, IMSO Assembly Report. 19 September 2002. 369 The rest of this section is based on an interview with Nick Palmer from Inmarsat, 17 Jan 2003. 370 Para 55, Sagar, 2002.

LN1:#20065849 113 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 114 Like most other companies, Inmarsat also has standard insurance policies insuring its assets and property and covering, business interruption public and products liability, directors and officers and employers liabilities.

Inmarsat’s insurance against third party liabilities is broad. It insures against failures in network operations, including outages from LESs, satellites and ground stations and the potential liability that might come from outages. Inmarsat relies on this insurance in respect of demand assigned services but additionally disclaims any liability relating to its leased services (which are pre-emptible), which includes space segment leased for navigation services.

Inmarsat began insuring against third party legal liability in general arising from network interruptions when it started to supply aeronautical services in order to deal with risks that might arise where, for example, two aircraft collided as a result of an Inmarsat failure.

There is some risk-sharing, but on a voluntary basis. As part of the LESO Agreement, a LESO may join with Inmarsat in its third party liability cover.

Inmarsat’s methods for dealing with liability, through a combination of insurance policies, operational practice and sharing with service providers, offers a good model for Galileo.

7.3.6 RISK MANAGEMENT AND RISK SHARING

In the context of PPPs or PFIs, risk management and risk sharing mean allocating risks to those best suited to manage the particular risks. However, in the Inmarsat case, virtually all risks are assumed by Inmarsat itself (or, in the last resort, its shareholders). Thus, this section does not so much explore how the risks have been allocated as examine how the risks are managed. See also Annex 3 for more detail on re risk management generally as well as the previous section on third party liability.

There is some, but relatively little sharing of risk between the Public Authority (IMSO) and Inmarsat, although the PSA does refer to risks, at least indirectly.

Inmarsat, somewhat like other companies, must manage many different types of risk, operational, financial, security and otherwise.

In the first instance, responsibility for risk management lies in the hands of the Inmarsat Ventures’ Audit Committee, whose members are independent non-executive directors. The Audit Committee meets at least twice each year and has particular responsibility for monitoring the adequacy and effectiveness of the operation of internal controls and ensuring that the group’s financial statements present a true and fair reflection of the group’s financial position. The Committee also pays particular attention to the implementation of the requirements of the Turnbull Report371 relating to risk management in the group. Its duties include keeping under review the scope and results of the audit, its cost effectiveness, the management process, and the independence and objectivity of the internal and external auditors. These meetings are attended by the Chief Financial Officer and the internal and external auditors.372

The Inmarsat Ventures board acknowledges its responsibility for establishing and maintaining the group’s system of internal controls. The system of internal controls is designed to manage

371 See Annex 3. 372 p 28, Inmarsat Ventures Annual Report 2001. Although Inmarsat is not yet a listed company, it has nevertheless implemented a risk management process along the lines of the Turnbull Report, which, it says, is embedded throughout the whole of the company. Indeed, it says it follows the Turnbull Report “to the letter, and has done so since 2000. Inmarsat wants model corporate governance and to demonstrate it before the IPO.” Interview with Nick Palmer, 17 Jan 2003.

LN1:#20065849 114 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 115 rather than eliminate the risk of failure to achieve business objectives and can provide only reasonable and not absolute assurance against material misstatement or loss.

Inmarsat Ventures has implemented a risk management process to identify, evaluate and report significant risks within the business and to report to the board on how those risks are being managed. Risks are highlighted through a number of different reviews and culminate in a risk register, monitored by an internal risk management group, which identifies the risk area, the probability of the risk occurring, the impact if it does occur and the actions being taken to manage the risk to the desired level. The risk register is provided to senior management, to the board and to the Audit Committee on a regular basis.373

The internal risk management group seeks to identify and assess all risks, although only higher value risks are reported to the board. Lower threshold risks don’t feature in the reports to the board. Inmarsat has a monthly risk review process. The internal risk management group comprises representatives from across the company who are expected to identify all risks perceived in his or her part of the company. The group reports monthly to the Audit Committee and quarterly to the board.374

The Audit Committee receives regular reports from the internal and external auditors and assures itself that the internal control environment of the group is operating.

Inmarsat appears to have developed a commendable risk management practice along the lines recommended by the Turnbull Report. Like Inmarsat, whoever wins the Galileo concession should be expected to “embed” risk management in its organisational practice and the EC should be satisfied that such is and will be the case.

Risk management strategies

With key manufacturers, Inmarsat insists on having resident teams at the manufacturer’s facilities to monitor critical processes, testing and quality assurance and to work with manufacturers at a detailed level to jointly solve any key problem areas to their mutual satisfaction. It is one risk mitigation strategy, which has proved very effective. Another area of risk mitigation is joint funding arrangements for research and development and key technologies.

Inmarsat favours multiple sourcing from suppliers, particularly for launch vehicles. Inmarsat says it has a sophisticated approach to risk mitigation re launch vehicles. It works closely with launch vehicles suppliers and is able, if necessary, to switch from one supplier to another.

Inmarsat’s risk mitigation strategies re manufacturers, joint funding of R&D and multiple sourcing all appear to have proved effective and, therefore, could also be models for Galileo. Although much of the risk associated with Galileo may be expected to be carried by the GOC, not all risk can be transferred and, as mentioned elsewhere, the EC/ESA/JU and GSB should be satisfied with the GOC’s risk management and risk strategy as part of the concession contract.

Financial risk

The group uses derivative financial instruments to hedge its exposure to interest rate and foreign currency risk.375

373 p 29, Inmarsat Ventures Annual Report 2001. 374 Interview with Nick Palmer, 17 Jan 2003. 375 p. 66, Inmarsat Ventures Annual Report 2001.

LN1:#20065849 115 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 116 Like Inmarsat, Galileo will be a global system with services providers, users and revenues from many different countries in addition to those in the EU. Hence, the GOC may be expected to use similar instruments to those of Inmarsat to hedge its exposure to interest rate and foreign currency risk.

Spectrum Risks

Inmarsat user terminals operate in L-band spectrum (transmitting in 1626.5-1660.5 MHz and receiving in 1525.0-1559.0 MHz, a total of 34 MHz in each direction). Feeder links between the satellites and the gateway earth stations operate in the C-band fixed satellite service allocations. The 2 x 34 MHz spectrum is allocated globally to mobile satellite services in the Radio Regulations. The spectrum is currently shared between 10 MSS operators, together operating 22 geostationary satellites and providing global or regional services. The shortage of MSS spectrum continues to be a concern to MSS operators. New operations have only been possible through innovative frequency reuse methodologies; however, not all operators have access to their full required spectrum because the spectrum demand exceeds the availability. Due to the recognised shortage of MSS frequencies, the UK and other administrations proposed additional allocations for MSS at WRC-97 and WRC-2000. These proposals were not successful. Further proposals for additional allocations are again being considered for WRC-2003.376

Regulatory licensing risks

As mentioned in section 7.2.2.13 above, like other mobile satellite network operators, Inmarsat and/or its service providers and/or users are obliged to obtain licences in every country where service is to be provided (possibly up to 200 countries). It is therefore obvious that the mobile satellite operator cannot pay the excessive licence fees and remain in business.377

Operational risks

Inmarsat insures launches to some extent. It uses innovative and individually tailored insurance strategies. It trades off full insurance on one hand against in-orbit and on-ground spares on the other. In-orbit failures have been very rare in the mobile satellite industry so it has not been Inmarsat’s practice to insure against those risks, however, as they have recently become more common amongst other satellite operators, Inmarsat plans to start insuring against in-orbit failure in due course. In any event, Inmarsat’s previous generation satellites act as spares. It has five Inmarsat-3s in orbit. Of these the fifth was originally built as a spare and Inmarsat also has its entire generation of Inmarsat-2 satellites which carry leased traffic which is pre-emptible. If there was an Inmarsat-3 failure, the remaining satellites could be flexibly redeployed depending on the situation at the time.378

Galileo may well follow Inmarsat’s example of using a combination of insurance, on-ground and in-orbit spares to deal with operational risks.

7.3.7 RELATIONSHIP BETWEEN THE PRIVATE ENTITY AND THE COUNTERPARTY TO THE CONCESSION

IMSO is required to provide IMO with regular reports, at least once yearly, on the performance by the Company of its obligations under Clause 2.1 of the Public Services

376 p. 1, Response to “Radio Spectrum Management Review: A Consultation Paper” [undated]. 377 p. 3, Response to “Radio Spectrum Management Review: A Consultation Paper” [undated]. 378 Interview with Nick Palmer, 17 Jan 2003.

LN1:#20065849 116 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 117 Agreement.379 As mentioned above, IMSO and Inmarsat have formed a Public Services Committee which meets regularly to monitor the performance of Inmarsat’s public service obligations and to sort out any problems.

Judging by the IMSO Director’s reports to the IMSO Assembly and to IMO, IMSO and Inmarsat appear to have established a relationship which works successfully. Undoubtedly, this is helped by the regular meetings of the Public Services Committee as well as by the fact that the IMSO directorate is on-site, i.e., in Inmarsat’s headquarters building. The EC and ESA may wish to consider the utility of a similar practice with the GOC, i.e., not only regular meetings but an on-site presence. IMSO as the Special Shareholder receives the same reports as any other shareholder and is able to attend any shareholder meeting. While this is not exactly the case with the DCSA in the case of the DFTS and BT, it has an approximate parallel with the DCSA sharing or having access to BT’s DFTS information management system. These similarities between the DFTS and Inmarsat cases and the success attributed to the relationships as they have developed suggest that the EC and ESA take similar initiatives with the GOC.

7.3.8 REMEDIES IN THE CASE OF DEFAULT BY THE PRIVATE ENTITY

Various provisions in the PSA provide for remedies in the event of a default by Inmarsat.

Clause 6 of the PSA says: “No delay or failure by Holdings or the Company in performing any of their obligations referred to in this Agreement shall constitute a breach of this Agreement nor give rise to any claim or action against either of them to the extent that such delay or failure is caused by an event of force majeure. If either Holdings or the Company is unable to carry out any of such obligations by reason of an event of force majeure, it shall promptly advise the Organization thereof in writing and shall use its best endeavours to resume the performance of its obligations so affected.”

An event of force majeure is defined as any act, event, condition or other cause of a compelling nature which is not reasonably within the control of either Holdings or the Company.

The key clause re remedies is Clause 7 which says that “Holdings and the Company agree that the Organization would be irreparably injured by a breach of the Company’s Public Service Obligations referred to in Clauses 2.1 and 2.2, or a breach of Holdings' obligations under Clause 19 of this Agreement, and that the Organization shall be entitled to equitable relief, including injunctive relief and specific performance in the event of any breach of those provisions of this Agreement. Such remedies shall not be deemed to be the exclusive remedies for a breach of Clauses 2.1, 2.2 and 19 of this Agreement and shall be in addition to the remedies available under Clause 17.” Clauses 2.1 and 2.2 refer to the provision of GMDSS services and non-discrimination respectively (i.e., not all of Inmarsat’s public service obligations). However, Clause 19 says that Inmarsat Ventures agrees with the Organisation (IMSO) that, in addition to performing obligations specifically imposed upon it under this Agreement, it shall take such steps as are necessary, and are within its powers, at all times to ensure that the Company fully and punctually performs its obligations hereunder, including, in particular the obligations set forth in Clauses 2, 3 and 15, and Holdings shall not, directly or indirectly, by any act or omission, frustrate the ability, or cause the failure, of the Company (Inmarsat Ltd) to perform its obligations. Clause 2 contains all of the public service obligations, including the two already mentioned as well as those relating to peaceful purposes, seeking to serve all areas where there is a need for mobile satellite communications, and fair competition. Clause 3 says the Company shall take into account the relevant international standards, regulations, resolutions, procedures and recommendations

379 Article 4.3, PSA.

LN1:#20065849 117 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 118 of the International Maritime Organization and the International Civil Aviation Organization, and shall observe the relevant provisions of the Constitution and the Convention of the International Telecommunication Union and the regulations made thereunder. Clause 15 refers to the Company’s paying IMSO secretariat costs.

These clauses are cited in some detail, perhaps more than necessary, but they appear to be somewhat strangely worded to the extent that Clauses 2.1 and 2.2 only are directly cited in Clause 7 re remedies, while the other obligations in Clauses 2.3, 2.4 and 2.5 and Clause 3 are only indirectly referenced via Clause 19. This somewhat “strange” wording may be because Clauses 2.1 and 2.2 re the GMDSS services and non-discrimination are rather more easily remedied than the less specific and less easily enforceable public service obligations in Clauses 2.3, 2.4 and 2.5. These latter public service obligations appear not defined specifically enough to be enforceable. They could be regarded expressions of intent, that Inmarsat should use its best efforts to fulfil them.

The EC/ESA/JU should ensure that remedies built into the Galileo concession are clearly worded so as to be enforceable. This should not mean that certain provisions that express best efforts should be omitted, only that the EC/ESA/JU as well as the concessionaire are clear about what is enforceable and what is not.

No waiver by the Organization, Holdings or the Company or failure to perform any provision of this Agreement shall operate or be construed as a waiver in respect of any other or further failure whether of a like or different character.

Under Clause 17, IMSO, Inmarsat Ventures and Inmarsat Ltd agree to use reasonable efforts to resolve informally and expeditiously any disagreement or dispute about Holdings and the Company’s compliance with their obligations under the PSA. If IMSO determines that either Inmarsat Ventures or Inmarsat Ltd is in default in complying with its obligations, and is unable to resolve the matter to its satisfaction with Inmarsat Ventures or Inmarsat Ltd through informal means, IMSO may take any of the following actions:

(a) IMSO may notify Inmarsat Ventures and Inmarsat Ltd, in writing, that it wishes to meet with management representatives to discuss the alleged default, in which case Inmarsat Ventures and Inmarsat Ltd must agree to such a meeting within two weeks.

(b) IMSO may notify Inmarsat Ventures and Inmarsat Ltd, in writing, that it wishes to meet with the Boards to discuss the alleged default, in which case they must agree to such a meeting within four weeks.

(c) Pursuant to Article 70 of the Articles of Inmarsat Ventures, IMSO may requisition the Board to convene an Extraordinary General Meeting.

IMSO, Inmarsat Ventures and Inmarsat Ltd may submit any dispute to arbitration, to be finally settled under the United Nations Commission on International Trade Law (UNCITRAL) Rules. The appointing authority shall be the London Court of International Arbitration (LCIA).

These provisions do not preclude IMSO, Inmarsat Ventures or Inmarsat Ltd from bringing any proceedings in the Courts of England.

The EC may wish to build into the Galileo concession contract an escalating set of remedies similar (but not limited) to those available to IMSO, including the means and rules of arbitration.

LN1:#20065849 118 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 119 7.3.9 DURATION OF THE CONCESSION AND BREAK MECHANISMS

Under Clause 18, the PSA may be terminated by written agreement among IMSO, Inmarsat Ventures and Inmarsat Ltd at any time; by written notice given by IMSO to Inmarsat Ventures and Inmarsat Ltd at any time; or if amendments to the SOLAS Convention are adopted so as to provide that carriage of ship earth stations operable with one or more other global satellite systems will satisfy GMDSS requirements, Inmarsat Ventures and Inmarsat Ltd may give joint written notice to IMSO of their intent to terminate the Agreement, and termination will be effective three years after the notice was given or when the amendments formally enter into force or when IMO determines that the GMDSS requirements are being satisfied by other satellite system operators, whichever is later.

IMSO, Inmarsat Ventures and Inmarsat Ltd are expected to review, in consultation with the IMO, at intervals of not more than five years starting on the date of the Agreement, the extent to which any of the GMDSS services are being or may be provided by other satellite system operators.

7.4 LESSONS LEARNED

The Inmarsat case study makes clear that a PPP/private sector structure is better than an intergovernmental structure, at least as Inmarsat was structured prior to its privatisation. This case study also makes clear that it is possible for a private sector entity to meet public service obligations imposed by an intergovernmental organisation.

There are a number of mechanisms which can be used to ensure public service obligations are fulfilled, in particular the use of a Special Share, a Public Services Agreement and a Public Services Committee comprising representatives from the intergovernmental organisation and the private sector entity. The regular reporting by the IMSO director to the IMSO Assembly and to IMO undoubtedly reinforce these mechanisms.

Although it took a long time to restructure Inmarsat – the best part of 10 years – this length of time was not unexpected from the outset, at least on the part of some of those who were involved in the process. This long duration needs to be seen in light of the fact that Inmarsat was the first ever IGO to be privatised. Also, the time taken, although long, was still somewhat shorter than that taken to spin off the DFTS.

It is clear that Inmarsat benefited from contracting early with external advisors and specialised legal experts, as the National Audit Office and Public Accounts Committee have recommended in the instance of UK government PFIs.

The Inmarsat case is somewhat different from the DFTS and Skynet especially in the sense that there was no competition for implementing the Inmarsat system by spinning it off as a result of a tender, as happened with DFTS and Skynet. It is also different in the sense that Inmarsat will not have to bid against competitors for another PFI contract as BT and Astrium will need to do in 10 or 15 years. Nevertheless, there were many competing forces within the overall Inmarsat structure, among Parties and Signatories, from regulators, notably from the FCC, as well from existing and emerging competitive MSS operators. And competition still stares Inmarsat in the face every day, as it does BT and Astrium, in its management of the satellite system. If Inmarsat services are not competitively priced, users will gravitate to other suppliers.

These competing forces were partly responsible for the fact that there was no clear vision at the outset as to how Inmarsat should be restructured or into what form it should eventually emerge. This experience is not so different from that of the DFTS. Although the EC and the Galileo community appear to have a reasonably clear and shared vision that Galileo should be spun off as a concession, Inmarsat’s experience, like that of the DFTS and Skynet,

LN1:#20065849 119 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 120 strongly suggest that the final form may not be what might be (or might have been) envisaged from the outset.

Indeed, it would appear that neither IMSO nor Inmarsat have reached the end of the road as far as restructuring is concerned (if that road ever does have an end point), since IMSO is now considering amendments to its Convention so that it is not an IGO with oversight of only one specific operator. Inmarsat may change further too, at least to the extent that it may not have to deal with public sector obligations at all if IMO accepts that GMDSS services can be provided by others apart from Inmarsat. It is, however, unlikely that Inmarsat would want to shed those public service obligations since the cost of fulfilling them is a tiny fraction of its overall revenues and there can be no doubt that some of those public service obligations (notably those flowing from the GMDSS) contribute to Inmarsat’s bottom line. If the maritime community did not have to comply with the GMDSS and if Inmarsat were not a specified part of the GMDSS, Inmarsat would have fewer ship earth station fittings than it does today.

The overall Inmarsat structure will certainly change further as its LES network is further rationalised from the legacy network which Inmarsat Ltd has inherited. Inmarsat may also change further as a result of the IPO and the dilution of shareholding.

Undoubtedly, it helps to have a clear vision from the outset, but the Inmarsat experience also highlights the need to build a consensus among all stakeholders as quickly as possible and to maintain flexibility in order to achieve that consensus. As the Inmarsat case makes evident, a good, working relationship between the Public Authority (IMSO) and the private sector entity providing the desired services (Inmarsat) is vital. While this can be spelled out in contractual terms to some extent, it is difficult to capture in a contract the trust, personal relations and shared vision that are essential to achieving success.

Our recommendations and conclusions arising from these case studies are set out in Section 11.

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8 ANALYSIS OF THE ‘TOLL-COLLECT’ ROAD TOLLING SCHEME IN GERMANY

8.1 BACKGROUND

The road duty for HGV, ‘Toll Collect’, Scheme in Germany has more similarities to Galileo than simply the fact that it will incorporate Satellite Position Services. The scheme is a very complex one, but if fully implemented will not only benefit road users but will also have a balance of public and private benefits that could assist in making Galileo a success.

Germany has not had the private sector involvement in public infrastructure projects that other countries within Europe have enjoyed over the last ten years. However over the last few years real private investment has taken place, not only with finance, but also with build expertise and operations experience.

This initiative in Germany is now known as PPI , Private Participation in Infrastructure, which is a type of PPP. The most popular style of PPI is BOT, being Build, Operate and Transfer. The private sector is enjoying an increasing involvement in all or several steps in the value chain for the provision of infrastructure, including planning, financing, construction, operation, maintenance, and refinancing through user charges.

In Germany’s case the problem area of infrastructure is in the road sector. For years, the highway system in Germany has been the envy of other leading European nations. Consistently seen within the country as investment in the public good, the roads have historically been operated and maintained with great success. Investment came through the general tax system and no direct user charges were necessary.

However with the public sector’s investments going elsewhere, maintenance has been ignored, and with the increasing traffic levels and HGV usage the highways are not what they once were. The long-term solutions are:

• the extension of most of the main highways to six lanes instead of four;

• an improvement of maintenance; and

• construction of new highway links to improve traffic flow.

8.2 INSTITUTIONAL STRUCTURE

A scheme for the improvement of the highway system will require the injection of private investment and expertise. 1994 saw a watershed for investment when a necessary change was made to German legislation to allow a flow of private involvement. A federal law, the Fernstrabenbauprivatefinanzierungsgesetz (FstrPrivFinG) was passed, which allowed private companies to construct, maintain and operate new roads and to levy user charges according to the BOT model.

This development resulted in the implementation of a set of 14 long term road projects in which the BOT model would be adopted that were selected by federal and regional ministries. The German ministry of transport and federal government decided that they would establish an institution to manage revenues from the HGV toll and finance maintenance and extension programmes of road infrastructure.

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The first major step in setting up this institution was to run a concession bidding process to find the right consortium to design, build, install and operate a toll collection system for a 12 year period commencing in 2004. The initial proposal was to raise a toll based on the distance driven by the HGV. The toll would be collected using on-board units and the existing infrastructure of GPS and cellular telecommunication. This is a relatively straight forward arrangement. The concessionaire will only have to deal with one institutional body, in the form of the Federal Ministry for Transport, Building and Housing (BMVBW). All public funds will be released from the BMVBW. The concessionaire will then have an arrangement with the BMVBW concerning the toll revenues. There will be no management influence by the public sector once the contract and concession agreements are decided at contract award (unless there are serious over-runs from the concessionaire). The BMVBW will in turn interact with the central German government in relation to policies, legislation and funding profiles. Thus the clear public authority in this case will be the BMVBW, without exception.

8.3 SELECTION PROCESS

The BMVBW put out an ITT in early 2000. Applicants were invited to design, build, implement and operate a toll collect system. The original specifications stated that the public sector would invest 20% of the infrastructure costs of the toll collecting system.

The bidding consortia would have to finance the remaining infrastructure costs and in return would be awarded a substantial proportion of the tolling revenues. The HGV duty that would be collected for distance travelled would replace the existing static duty per annum currently enforced on owners of HGVs.

After a European wide bidding procedure in July 2000, there was a down selection to the following two consortia whom the federal government considered were capable of assuming the scheme:

• Toll Collect – Daimler Chrysler, Deutsche Telecom and Confiroute

• AGES – Vodafone, Aral and Shell

On 20 September 2002 the contract to ‘BOT’ the road tolling system was awarded to ‘Toll Collect’. The statement from the federal government was that they believed the consortium had the best mix of, “mobility management, road tolling experience and communications know-how to deliver the more efficient system, in what is believed to be a dramatically innovative project”.

The rules that govern the operation of the road tolling system were not to be so dynamic though, and Toll Collect were taking on a certain level of risk with the contract award.

8.4 ORGANISATIONAL MODEL

Toll Collect consists of three companies:

• Daimler Chrysler (45%);

• Deutsche Telecom (45%); and

• Confiroute SA (10%).

LN1:#20065849 122 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 123 As stated previously, the project company will design, build, install and operate the road tolling system on all German highways. All lorries weighing more than 12 tonnes will be required to purchase a permit for each motorway trip, or pay for usage by the means of an in vehicle unit which uses GPS positioning and GSM communications.

The Government investment into the project would be up to 20% of the infrastructure costs of the system. Also the public sector are starting an initiative to provide the OBUs to all HGV owners that would like them fitted. This is intended to encourage a wide spread use of the system as quickly as possible. The predictions are that by the end of the first operational year, 80% of HGV owners will have the on-board unit.

The remaining 80% of the costs of system are to be raised by private finance. The financing risk is assumed by Toll Collect and it is for the private entity to organise a debt profile through banks and investment houses. This of course is expected to be in conjunction with an equity contribution from the partners within the team, i.e. Daimler Chrysler, Deutsche Telecom and Confiroute. The return Toll Collect will receive for this will be a substantial amount of the Toll Revenues.

Toll Collect has to cater for all types of user. There is a requirement for a collection mechanism to be in place for occasional users. Therefore, the user has the following options:

• Have the on-board unit installed by Toll Collect. This system and its installation will be free for the user. The public sector will pay for all requested on-board units to be bought from Toll Collect and installed through a government grant initiative;

• Pay for a permit through the post or over the internet; or

• Pay for a day permit, or per use for their planned route at petrol and service stations on all German Highways.

It is Toll Collect’s responsibility to maintain a system that can deal with different types of user. In this regard, it has entered into a sub-contract with a company called Hoff & West, to deliver machines for manual collection to be installed at all major petrol and Service stations.

The operational model therefore works as follows:

• registered user with OBU drives from A to B;

• Toll Collect control centre monitors travel of each user with assistance of GPS and GSM;

• signal is sent through communication network of users travelling from A to B, to control centre;

• a charge is calculated in respect of travel from A to B, and is invoiced within automated system; and

• invoice is sent to owner of HGV either through an electric billing system or through the postal service. The money collection through the manual paying system passes directly to Toll Collect.

The complexity arises after this relatively simple process. Toll Collect receive all revenues accrued from the Rolling Tolling system of HGVs. This will be fully explained from the understanding of the agreement between the public and private entity.

LN1:#20065849 123 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 124 8.5 AGREEMENT BETWEEN PUBLIC AND PRIVATE ENTITY

When the selection process identified the winning consortium, the public sector established the contractual arrangements concerning financing, duration and revenue sharing.

The principal features of this are as follows:

• Government finance contribution to Toll Collect is 20% of the total infrastructure costs over the 12 year concession period.

• Government assumes cost of buying and installing OBU to any user who requests them through an agreement with Toll Collect.

• Government sets a limit on the level of tolls which may be charged. The selection process included an assessment of whether the consortium could make the business case work with the limits on the tolls. The cap on tolls has implemented to ensure that no consortium would take advantage of the monopoly that the government would award them through this contract.

• Toll Collect retains 20% of the Toll revenues that are collected. This is the incentive to Toll Collect for arranging and taking on the risk of building, operating and producing a financing plan through private investment.

• The remaining revenue is directed to the public sector and then used for future PPI in Germany for road and transportation projects.

• If for some reason the revenue for a certain year is not sufficient to cover the operational costs for the concessionaire then the public sector ensures that a top up contribution goes to Toll Collect pursuant to the agreement that was reached on contract award. Toll Collect have stated costs documented for each year of the twelve year concession period. The public sector therefore knows what the levels of expenditure are for the concessionaire each year. A top up level can be agreed on.

• Toll Collect therefore has no revenue risk.

The ownership issue is clear. At the end of the concession period the infrastructure and tolling system will be transferred back to the public sector as, it is ultimately the public sector’s asset.

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80% Toll Revenues Future Road Programmes

BMVBW (Public Body)

Top-up 20% public funds Costs 80% Toll if required Public Revenues Equity Private Funds ‘Toll Collect’ SPV Bank Debt Concessionaire Toll Toll Revenues Revenues Toll Collect Subsidiaries

Control Infrastructure Manual Centre Procurement Tolls

HGV OBU Sub- HGV non- Users Contractors OBU Users

This structure encourages private sector involvement in a scheme deemed to be for the public good and opens up opportunities for future road developments in Germany. The public sector’s goal is to open up future PPPs in Germany through toll collection.

Toll Collect will operate the toll collection system for the 12 year period, and will be eligible to retain 20% of toll revenues collected on all German highways. At the end of this period the infrastructure will be transferred to the public sector, and there will be a bidding process put in place for a new operator (with scope for upgrades to system).

The remaining 80% of the toll revenues offer scope for future public benefits in infrastructure programmes. The BMVBW are planning to use the toll revenues as an incentive for private sector investment. The planned structure will be as follows:

• Future road developments in Germany will be constructed and operated by the private sector. Public sector investment in future projects will amount to up to 50% of the construction costs. The remaining costs will be covered by private finance.

• The incentive for the private sector to become involved is that it will receive 80% of the revenues collected, whether it be a new road, or a development of an existing one.

• Toll Collect will still receive 20% of the revenues accrued.

LN1:#20065849 125 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 126 • The German government receive the infrastructure and operational network that they desire which is run and operated by the private sector.

Service Guarantees Toll Collect has a very direct incentive for providing the guaranteed levels of service. If for any reason the system is not operational due to a system fault then no revenue is collected from the users. The fundamental question here is who suffers because of this.

The system depends on the GSM communications network, local base stations and the GPS system. All areas of dependence are thus not controlled directly by Toll Collect. There is no publicly available information on the liability issues surrounding the use of these systems. These questions therefore remained unanswered. Is it that due to the agreement by the BMVBW on the use of these systems to implement the Collect system, that BMVBW will take on the impact of not receiving the revenues if the system malfunctions? Or does Toll Collect suffer as well if the revenues are not collected because it has used these dependent systems in their operation design?

8.6 SUMMARY IN LIGHT OF GALILEO

The structure and organisation of the German Road Tolling system contains many similarities with Galileo as it is currently foreseen:

(a) The projects are derived by the public sector in order to obtain substantial public benefits;

(b) The public sector are not looking to cover the costs of the infrastructure completely and are looking for substantial private sector involvement and expertise;

(c) Private sector involvement will ensure that the maximum public benefits are obtained;

(d) There will be a cap on the level of public sector investment whereby this investment ends in the early stages of the programme; and

(e) There is a public sector body interacting with the concessionaire within the organisational structure to ensure that both parties have a fluid relationship and that they meet the schemes’ requirements.

The similarities do not however extend to the particular details of the project such as risk and financial rules:

1. Toll Collect has an in-built payment mechanism for its business, thanks to the public sector introducing legislation to ensure revenues flow from HGV users to Toll Collect. The users of HGVs have to pay a duty for distance travelled. This is not currently seen as something that could easily happen with Galileo, although there is scope for it in areas such as air transport, and the adoption of Satellite Navigation to be used as part of the standard air traffic and landing framework.

2. Toll Collect assumes very little financial risk because the public sector underwrites its costs if revenues do not meet the required levels. The Galileo Concessionaire currently is seen to have substantial revenue risk, although the PWC Report indicates that the revenues accrued could also be substantial. This is the balance change between the two projects. Toll Collect has no revenue risk whatsoever, and significant problems are only likely to arise if its build and operation of the system does not meet planned budgets or if there are technical faults. The Galileo concessionaire by contrast has build, revenue and finance risks. There could be a change to the Toll

LN1:#20065849 126 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 127 Collect model, however, for the public sector to underwrite the revenue risk (with PSSP during the operational phase) they would have to be a clear set of public benefits associated with that investment.

3. Toll Collect has a public sector body enforcing revenue collection rules on it. It is only allowed to keep 20% of the revenues collected, and the toll charges are not permitted to rise above a certain level. Currently the Galileo concessionaire would have complete discretion in terms of revenue collection and setting levels of charges. There is a case for a change of this current policy though. The Galileo revenue structure could be made similar to Toll Collect, with an exchange of a revenue sharing policy, for more public sector investment during the operational phase. The public sector could put in more funds during the programme, and could, for example, be entitled to receive 40% of the revenues collected by the Galileo Concessionaire. There has to be direct benefit for the concessionaire, i.e. the public sector is responsible for covering costs if revenue is low. Also the public sector would expect direct benefit, i.e. a larger share of the predicted substantial revenues later on in the operational phase. Exactly what the balance is, is another question.

4. Toll Collect does not take on the risk of providing service guarantees. It operates the system and the revenue collection mechanism. It relies on the fact that the GSM network and GPS will be operational and working. If revenues are not being collected because of a fault in the system because either GSM or GPS are not fully operational then Toll Collect will have to report this to the BMVBW. This could lead to a reduction of top up funds being released to Toll Collect.

Toll Collect is a relatively simple operation that is being created as a mechanism to collect revenues for future road improvements. It is however an initiative that the German government have made happen, and have introduced legislation to facilitate the project. There is a relatively straightforward relationship between the public and private entities which will help the operation of it, and of course will help the flow of private investment into public sector infrastructure.

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9 ANALYSIS OF ‘MESSINA STRAITS’ ITALIAN BRIDGE PROJECT

9.1 BACKGROUND

The Messina Straits Italian Bridge project has, as a concept, been around for years. The project is for a bridge between mainland Italy and Sicily intended to address the chronic congestion problems crossing the straits. At present, the ferry crossings are overrun and in immediate need of maintenance, while the railway links are both time consuming and impractical. The daily bottlenecks on each side of the straits are badly affecting local businesses and the economy of both regions. This is a big public sector requirement, with huge public benefits, which requires big private sector investment. The advantages are expected to include the following:

• meeting a REAL demand of passengers and good transportation (the demand can be quantified looking at current traffic levels;

• reviving surrounding areas;

• boosting metropolitan area in the Mediterranean;

• creating new economic space by connection of Italian regions; and

• benefiting the construction industry through the high skilled technology requirement and its labour forces.

Parallels can be drawn here with Galileo. There are a number of potential benefits from the Messina Straits which are difficult to quantify, but would be apparent if the infrastructure were there. There are people that would use the bridge. Moreover, major infrastructure programmes throughout Europe tend to revive industry and surrounding areas. But the main concern here is that no REAL numbers can be attributed to such benefits.

Currently people in the area survive without the use of the bridge. There is a fairly efficient ferry service, and there is a lot of political opposition against the connection of the two areas. However, the bridge would bring though is more efficiency to the whole area, i.e. a better method of travelling from one area to the next, thereby cutting down journey times for businesses that use the route.

Galileo is similar. People are currently going through their daily lives without Galileo. But, if Galileo was available, positioning services would be available at a higher standard. The use of positioning services would become more widespread. As the wave of modern day technology continues to affect more areas of everyday life, Galileo would enable people, whether for work or leisure, to improve the efficiency and quality of their lives. As with the Messina Straits Bridge, however, the real effects of Galileo will be difficult to quantify until the infrastructure and systems are in place.

The Messina Straits project tackles an array of complex institutional/political issues and has thus encountered significant problems in being realised. The dynamics of the project have suffered so far because of the strong public sector influence within Italy. Italy’s level of public sector spending on infrastructure has been substantially lower then other leading European countries. However, state owned companies and subsidiaries still make up around 25% of the economy, with the number being closer to 50% in the south of Italy.

LN1:#20065849 128 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 129 The ‘Messina Straits’ bridge was identified by the Italian government as a long term project that had to use a PPP structure to ensure the maximisation of private sector investment. The problems within Italy have historically been that the legislation and regional government rules do not maximise potential in infrastructure projects. Regional governments are still not required to adopt national initiatives such as this scheme, and could provide a barrier to smooth implementation of homogenous models within specific sectors in Italy.

Galileo has also suffered because of political complexities. The Messina Straits project has been around for years, but it has only been in the current administration of Prime Minister Berlusconi that we have seen the project begin to move in the right direction. Discussions with the regional governments have focussed on the high level of public money required for the project, and there has been a reluctance to allow private sector involvement. Berlusconi has started to break down these barriers by putting in place legislation which allows more private sector investment.

Although not exactly the same, Galileo has also suffered because of lack of agreement within the public sector. To maximise the right level of involvement from the private sector either through infrastructure or finance, there has to be real incentive for them to get involved. Delays in private/public projects can seriously affect the involvement of the private sector and will result in a higher cost for all that are involved.

Press coverage of the project has been high and the political constraints on the project could become overwhelming:

‘Prime Minister Silvio Berlusconi has made the 3.3 km fixed link for road and rail one of his government’s top priority infrastructure projects. It is seen that it would be very difficult for him to win re-election if the first stones are not in place. There are many questions hanging over the ambitious project, which opponents are calling another ‘cathedral in the dessert – i.e. beautiful, but serving no purpose”. 380.

Pressure is coming from different areas. Economists have also attacked the business assessment performed by PWC, stating that it is flawed:

“The analysis has not taken into account that the traffic across the bridge will not be great and therefore self financing is unlikely to be feasible. The traffic foreseen for the bridge will be modest. Inter-urban short distance traffic will find it quicker to go by fast ferry, while long distance freight will find the sea highways a much cheaper competitor, Plus long distance passengers are likely to continue to travel by air”.

“The Italian government will make the same mistake as the Japanese government has for the past decade attempting to re-ignite its stagnant economy with mega infrastructure projects, only to find itself with potentially unsustainable debts, both for the government and the banking sector, without achieving the desired economic growth, plus causing huge environmental damage”.381

As with Galileo, there is scepticism regarding the economic forecasts. In the case of Messina Straits, the competition from ferries will still exist. Confidence here will have to come from a comparison with other major bridge/tunnel projects, which have replaced more traditional methods of transport. While there are alternative methods of crossing the straits, there will always be people with the opinion that the bridge will not have the use that is stated. Because of the presence of technologies such as UMTS and GPS there will always be the argument that Galileo will never have the demand to justify its existence.

380 Lloyd’s List International 16 January 2003. 381 Lloyd’s List International 16 January 2003.

LN1:#20065849 129 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 130 The key is to identify the main selling points with the new infrastructure/system over the exiting infrastructure/systems for the main users of them. For example, with respect to the Messina Straits project it is a fact that the journey time for people needing to travel from mainland Italy to Sicily regularly (especially train users) will dramatically improve. For Galileo there are enough performance improvements for the user to point to the fact that there could be a real need for it. But until user contracts are signed in the case of Galileo, or cars start crossing the bridge over the Messina Straits, the criticism and cynicism will not cease.

Infrastructure in South Italy and Sicily is in a very poor state and the argument is that public finance should be spent on other areas, rather than concentrated on the bridge. However, it is also arguable that the infrastructure industry in this region will thrive on the construction of the bridge

The public authorities involved feel that this is not the case. Mr Calarco, president of the Stretto di Messina states:

“The bridge will not be a cathedral in the dessert. It will link Sicily to the peninsula, will change the image of the region depicted as a land of bandits and will give back some self esteem to the inhabitants”.382

Pressure is on the administration from a variety of angles, which have contributed to the delays in the approval of the project’s operation. With these considerations in mind, the following section looks at the structures that have been put in place so far and the proposals for future induction.

9.2 INSITUTIONAL STRUCTURES

At the turn of the millennium, the Italian government started to put in place the institutional structure and legislation to enable this scheme to finally go ahead. Based on the UK’s Private Finance Initiative Task Force, the Unita Tecnica Finanza di Progetto (UFP) was set up to deal with project finance techniques. This body, established specifically within the Italian Treasury, was a specialised team of project finance professionals to provide project finance expertise to the public sector and to assist them in identifying projects capable of attracting the private sector.

In the context of the Messina Straits project it will require both the private and public sector to acknowledge the risks involved and, on the basis of a flexible contractual structure, to divide these such that the private sector is being paid adequately for the risks that it has been asked to assume.

As widely expected by the Italian project finance community, the Merloni Law was amended on 1 August 2002 by Law no 166 Article 7, 109/1994. This was vital as a fundamental problem with this scheme has been the rigid legal framework surrounding it.

The Merloni law has been adopted by the Italian government, on the advice of the UFP, to allow for more private sector involvement in the construction of the public infrastructure:

(a) The design, build, and operation of the Messina Straits bridge can now be performed by one consortium.

(b) The consortium will be obliged to have at least three partners with five years’ experience in the field of infrastructure construction (be it in bridges, roads, railways or toll collecting systems).

382 Lloyd’s List International 16 January 2003.

LN1:#20065849 130 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 131 (c) There are no longer any financial restrictions on the level of expenditure from public or private sectors for a project. For the ‘bridge’ there can now be as much public or private sector financial involvement as is agreed at contract award. This will allow a greater level of flexibility in government budgets and in finding the right sort of private sector investors.

(d) The term of concession is not restricted. For the ‘bridge’ the concession period will be in the region of 25-35 years, due to the nature of the project. This will allow significantly more forward planning for both public and private sector bodies

The Italian government have put in place the institutional structure to make sure that projects such as the Messina Straits bridge can happen. The UFP (based on the experience of the UK in areas of private sector involvement in public infrastructure) have, in the context of the bridge, set about the task of making sure that both public and private sector understand their roles, responsibilities and risks.

Galileo also requires both sectors to have a clear understanding of their respective responsibilities. If the public sector are responsible for the administration of this project then they will need to consider very carefully who they select to administer the project. The understanding of risk in this type of project is key. For the private sector to take on any form of significant risk, it has to understand the applicable terms and conditions, for example, is it transferable, will they get sufficient rewards for taking it on, etc.

A specially formed company named Stretto di Messina was incorporated by:

(a) The Sicilian and Calabria governments (two regional governments that will be linked with the formation of the bridge);

(b) A.N.A.S. - Italian Highway Agency;

(c) FS - Italian Railway Operator; and

(d) IRI/Fintecna - Italian State industrial holding company.

On 27 December 1985 Ministerial Decree no. 3437 confirmed and approved the concession, and the convention between A.N.A.S., FS and Stretto di Messina was signed for the preparation of the feasibility study and for the preliminary design of the work.

On 23 January 1998, a Directive issued by the Italian Premier declared the Company a body governed by public law in compliance with the EU directives no. 93/36/EEC, 93/37/EEC and 92/50/EEC that coordinate the procedures for the award of public contracts.

The concession that has been set up has had no direct private sector involvement up to this point. The delay from the company being formed to the actual starting of the design and build has been due to financial constraints and lack of private sector expertise. The intention is now for the bridge project to be structured as a PPP, with the Stretto di Messina working with the UFP alongside the private sector in a SPV. Fifty per cent. of the total infrastructure costs will be contributed by the public sector and the remainder funded by private investment.

9.3 SELECTION PROCESS

The complexity of this model is due to the lack of forward planning by the Italian government. The Stretto di Messina was formed as a public sector company charged with supervising the project, first as a traditional procurement project funded entirely by the public sector, and then as a PPP (looking for 50% of costs to be covered by the private sector).

LN1:#20065849 131 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 132 The selection process has not begun. PWC completed a full business assessment of the scheme, and the Stretto di Messina is waiting on the results of an environmental impact study before is presents its case to UFP and then to the Italian Government. However, thought has been given to the selection process:

(a) as discussed above, the consortium has to have at least three companies that have five years’ experience in work associated with ‘the bridge’;

(b) there will be an open bidding process, resulting in the selection of one company;

(c) there will be no down selection process as occurred in ‘Toll Collect’, nor the initial bid process proposed for Galileo;

(d) the chosen consortium will have to set up a SPV once the contract has been awarded;

(e) the consortium will be expected to have obtained appropriate financial expertise within their team to bring credibility to achieving financial viability; and

(f) the law allows Stretto di Messina to require a specific company structure and capitalisation. There will be a strong influence from the institutional body on the SPV during the concession period. Public sector involvement will be significant and could potentially hamper the private sector’s running of the programme.

The ‘Stretto di Messina’ will therefore select the winning concessionaire and contract the SPV to design, build and operate the Messina Straits bridge. In return the SPV will collect the toll revenues from use of the bridge. The risk will be whether the revenues accrued from the users of the bridge cover the costs assumed by the private sector.

The Italian public sector seem to want significant involvement with the chosen SPV. This could stifle the amount of interest from the private sector, especially in areas such as finance. Rules of private funding would require clarity concerning how the programme would be managed. If the public sector can change their commitment depending on the then-current political agenda, then it could result in a reduction of private investment.

The other major area of concern here is what happens if the administration changes hands during the process. If Berlusconi is replaced it could eventually affect the project due to the nature of the public sector’s heavy involvement within Italy. A change of government could result in a reduced commitment from the public sector, perhaps leading to a lack of public funding. If the heads of the regional governments are replaced, perhaps by different parties, would it affect the nature of the programme? Unfortunately these are events which could badly effect the Messina Straits scheme and which should be avoided for Galileo. Whatever the institutional body set up for Galileo (whether the JU or otherwise), it has to be independent of country or party politics and must agree, on formation, the long term goals of the programme. If any changes are to happen, that process has to be clear in order to make sure any change to the administration will not hamper the process.

9.4 ORGANISATIONAL MODEL

The Public Sector contribution has been set at approximately 50% of the infrastructure costs and an annual public contribution to the operation and maintenance (a form of public sector service payment). There is the possibility of shadow tolls also flowing through to the concessionaire, i.e. money accrued through a separate public fund which is used as a contribution to the infrastructure costs.

LN1:#20065849 132 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 133 The contribution from the public sector through operational payments and shadow tolls allow a certain degree of risk to be reduced for the concessionaire. The level of revenues during the operational period that the concessionaire would need for financial feasibility therefore would not be set so high, improving the likelihood of financing the project. The level of operational payment and shadow tolls would not be fixed. The recommendations by PWC were to set the level on a flexible basis, reducing the amount potentially if the traffic/use of the bridge is higher than predicted. This allows the public sector to distribute their contribution more evenly over time, not giving it such a high financial burden in the initial stages of the project.

The structure of public sector contributions through operational payments and shadow tolls have similarities here with the way Galileo could operate. Because of the nature of these programmes and the involvement from the public sector in the design and planning of the project, there has to be contributions from the public sector during the operation of the programme. The operational payments here are designed to be flexible, so the concessionaire would only receive them if the revenues from the users were not sufficient to cover operational costs and financing.

For Galileo a similar approach could work, but would not be advisable. The idea of operational/service payments for Galileo is that the public sector would pay for services it requires during the operation of Galileo. Because of the extent of the public sectors requirements having to be met during the design and construction of the Galileo system, the concessionaire should be able to access a steady return of revenues from public sector service requirements being met by the system.

The idea of shadow tolls should also not be excluded for the Galileo programme. It is a process that has worked very well across Europe in several infrastructure programmes and if there is an opportunity for it in Galileo it should be assessed as a clear possibility.

A steady contribution from the public sector in one form or another can improve the chances of success of the infrastructure that the public sector is seeking to put in place. It enables the concessionaire to have a certain degree of control over their financial planning, and gives less opportunity for unexpected financial disasters, which could hamper the public sector heavily in the future.

The Messina Straits scheme would only include the actual construction of the bridge and basic links to the local highways and railroads.

All Public Sector funds will flow through the Stretto di Messina company. From concession award, a prescribed financial plan will be put in place for public sector contributions. The concessionaire will know when the funds will flow to it. There will also be a clear plan of how the operational payments will flow through to the concessionaire. The rest of the infrastructure funds will have to come through the raising of private finance through:

(a) bank debt;

(b) investment house funds; and/or

(c) equity through industrial partners and from within the consortium.383

The clarity of the operational payments are crucial. It gives the concessionaire every opportunity to plan ahead and understand exactly what is required from them. This will have to be the case with Galileo.

383 See financing legal aspects report for examples.

LN1:#20065849 133 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 134 The finance will be taken on by the SPV as a risk in return for the revenues collected through the tolls collected from the bridge users. The risk is off-set somewhat by the contribution of operational payments from the public sector during the operational phase.

LN1:#20065849 134 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 135

Italian Government Funds Local Government

Operational Public funds Payments ‘Shadow’ Tolls for infrastructure Stretto di Messina (Public Company)

Public Funds

Bank Debt (approx. 50%) SPV Equity ‘Bridge’ Concessionaire Public Private Credit Investment Lines SPV Subsidiaries

Infrastructure Central Toll Control Operators Procurement Centre

Toll Revenues collected for Bridge Use

Sub Bridge Contractors Users

This diagram summarises the structure of the Messina Straits project. The SPV will take responsiblity for the design, build and operation of the bridge. The concessionaire will have subsidaries that carry out the different stages of the project. There will be an infrastructure procurement element for the final design of the bridge and the management of the bridge’s construction. Although the consortium will have an appropriate range of expertise necessary for design and build, there will be a set of sub-contracts for specialist skill requirements. There is also a requirement for a centralised control centre for automated actions once the operational phase has begun and a separate subsidary for revenue collection.

LN1:#20065849 135 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 136

10 LEGAL ANALYSIS OF PROCUREMENT RULES APPLICABLE TO THE SELECTION OF THE GALILEO CONCESSIONAIRE

10.1 THE LEGAL FRAMEWORK FOR THE TENDER PROCESS

10.1.1 INTRODUCTION

An effective public procurement policy is fundamental to the success of Galileo in achieving its objectives to generate sustainable, long-term growth and create jobs, to foster the development of a business capable of exploiting the opportunities generated by the European single market and competitive in global markets, and to provide tax-payers and users of Galileo’s services with the best value for money.

The economic significance of public procurement means that an efficient selection procedure for the Concessionaire can lead to significant savings for public authorities, and, consequently, for tax-payers. A policy of openness in public procurement also leads to less obvious benefits, such as fair, transparent and non-discriminatory award procedures, together with the possibility for suppliers to have recourse to national courts to assert their rights and limit the risks of fraud and corruption in administration.

10.1.2 THE PROPOSED PROCUREMENT PROCESS

The following diagram outlines a typical procurement process within the public sector.

Defining the procurement strategy

The public-authority defines its aims, decides what is needed, prepares the business case and then decides how the procurement exercise will be carried out. It will take account of market conditions, legislation and public-sector policy.

Inviting tenders

The public-authority invites suppliers to put in an offer, or tender – often in response to an advert in OJ or a trade magazine. In some cases suppliers have to pre-qualify before being invited to tender. They do this by answering a questionnaire or supplying information about their financial status, previous experience and references and so on.

Evaluating and refining tenders

The public-authority evaluates the tenders against set standards relating to value for money. This process usually includes a period of clarifying the tender before it is accepted.

Awarding the contract

LN1:#20065849 136 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 137

The public-authority awards the contract to the supplier whose bid offers best value for money.

Managing how the contract is put in place

Everyone involved works together to put operations in place for the forthcoming contract.

Managing the contract

The supplier and the authority manage the contract and the supplier’s performance is checked and monitored by the organisation.

Review and testing

The need for the contract will be reviewed regularly and after a set period of time the contract will be advertised again.

It is obvious from the outset that the procurement strategy for Galileo will need to be tailored to the specific needs of the public sector and the unusual nature of the project itself. In order for the private sector to provide the necessary capital for Galileo on a cost effective basis, it will be necessary for a long-term concession to be awarded to the Concessionaire. Whilst the Concessionaire will be obliged to comply with stringent covenants regarding service provision and will face potential loss of the concession should it fail to deliver, it is obviously desirable from the outset that the concession be awarded to a competent and financially viable Concessionaire which will provide the required services for the duration of the Concession without material disruption to the service being provided to both public and private sector consumers.

The tendering process in PPP bid projects is usually a two-step process involving a pre- qualification and down selection phase, followed by a competitive bidding phase. We note in the PWC Phase II Report that the favoured approach would be to replace the pre-qualification phase with a less onerous “Expression of Interest” stage. We agree that the use of a pre- qualification structure is not as necessary as is usually considered to be the case in the context of other PPP projects, since the potential field of competent bidders for Galileo is already relatively narrow. There is no need at the initial stages to eliminate interested parties (except those who are not serious about making a bid who can be eliminated by setting a moderate fee for receipt of the bid documentation). As the process evolves from the Expression of Interest Phase through to the Initial Bid Phase identified in the PWC Phase II Report, it seems probable that interested parties will start to consolidate into two or more bidding groups which will be required to develop a full business plan for the concession. Once the initial bids are evaluated, two bidders will be asked to develop business plans for the concession contract. It is during this phase that significant time, money and resources will be expended by the two selected bidders.

In reviewing the relevant procurement rules, we have focused on the procurement framework proposed by PWC.

10.1.3 THE LEGAL FRAMEWORK OF PUBLIC PROCUREMENT

The legal framework of public procurement is complex and includes:

LN1:#20065849 137 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 138 • EC and other international obligations, as implemented in domestic legislation or by virtue of direct effect;

• specific domestic legislation384;

• general contract and commercial law; and

• domestic case law.385

The EC and international procurement obligations outlined in this report are:

EC Treaty provisions which prohibit: (i) discrimination on grounds of nationality, either directly or indirectly (ii) restrictions on the free movement of goods and services (iii) restrictions on the freedom of establishment of service-providers and (iv) measures of equivalent effect;

EC Procurement Directives which: (i) reinforce the EC Treaty provisions for contracts in excess of certain values (ii) are based on principles of equal treatment, transparency and competitive procurement (iii) establish a framework of rules to which procedures for the award of supplies, works and certain services contracts by public bodies and various utilities must be adapted and (iv) are implemented by Regulations made by the Member States;

EC Remedies Directives which provide that, where the Procurement Directives apply: (i) suppliers harmed or at risk of harm from a breach of the EC rules (the Directives, the Regulations which implement them or any other relevant Community law, including the EC Treaty) are to have access to rapid and effective review systems with powers to grant interim and final remedies including powers to suspend the award procedure, to set aside decisions and/or to award damages and (ii) a corrective mechanism under which the EC can draw attention to alleged breaches and accelerate its consideration of infraction proceedings against the Member State in the ECJ; and

WTO Government Procurement Agreement which is designed to make laws, regulations, procedures and practices regarding government procurement more transparent and to ensure they do not protect domestic products or suppliers, or discriminate against foreign products or suppliers.

In Section 10.2, we examine EU procurement legislation and in Section 10.3 we analyse the relevant WTO procurement rules (which have been incorporated into EU law by amendment of the Procurement Directives).

10.2 EU PROCUREMENT LEGISLATION

All procurement in the public sector is in principle subject to EC Treaty principles (i.e. non- discrimination, equal treatment, transparency, mutual recognition and proportionality). These are not prescriptive rules that can be applied mechanistically, but broad principles, open to interpretation. Although the procurement directives put some ‘flesh’ on these principles, it should be noted that they too can be subject to differing interpretations.

384 In the UK, this would include legislation on corrupt gifts or unfair contract terms. 385 In the UK for example, this would include Blackpool and Fylde Aero Club Ltd v. Blackpool Borough Council [1990] WLR 1195 in which the English Court of Appeal held that at common law, there are circumstances in which, by putting out a contract to tender, an authority will bind itself to consider all the bids.

LN1:#20065849 138 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 139 10.2.1 EC TREATY

The EC Treaty does not specifically mention public procurement. It does, however, lay down fundamental principles which are generally applicable and which contracting authorities are obliged to observe when awarding all contracts, including those whose value falls below the thresholds for application of the specific rules laid down in the relevant procurement directive.

The main objectives of the EU’s public procurement policy are as follows:

• creation of the conditions of competition necessary for the non-discriminatory award of public contracts;

• rational allocation of public money through the choice of the best offer presented;

• suppliers' access to a truly single market for the provision of goods and services, with significant business opportunities; and

• reinforcement of competition among European enterprises.

The EC Treaty principle governing public supply contracts is the free movement of goods and, more specifically, the ban, established in Articles 28 et seq., on quantitative restrictions on imports and exports and all measures having equivalent effect. The principle of the free movement of goods, and the consequential ban on quantitative restrictions and measures having equivalent effect, applies both to goods originating in the EU and to goods coming from non-member countries which are put into free circulation in the Member States.

Articles 49 et seq. of the EC Treaty provide for the free movement of services. These rules apply generally to national rules that apply differently to suppliers from other Member States; they also apply to non-discriminatory rules that limit access to the national territory.

Both sets of rules are subject to limited exceptions on public policy grounds, provided that any restrictions are non-discriminatory and proportionate to the object pursued.

10.2.2 EU PROCUREMENT DIRECTIVES

The EC Treaty places a general ban on discriminatory measures and unfair treatment as outlined above. However, these prohibitions were not sufficient, on their own, to establish a single market in the specific area of public procurement. Differences between national rules together with the lack of any obligation to open up contracts to Community-wide competition often conspired to keep national markets walled off from foreign competitors.

Legislation was therefore needed to make sure that public contracts throughout the EU were open to firms from all Member States on equal terms and to make procurement procedures more transparent so that compliance with the principles laid down in the EC Treaty could be enforced more effectively. This was achieved through the EU procurement regime, which adopted a series of “directives” setting out common rules for the Member States of the EC to adopt into their national law. The four procurement directives386 are the cornerstones of the EU procurement regime:

The following set of directives (the “public directives”) cover contracts awarded by various public bodies (“contracting authorities”):

386 As implemented by domestic regulations passed by the Member States.

LN1:#20065849 139 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 140 • Council Directive 93/97/EEC concerning the coordination of procedures for the award of public works contracts (Works Directive);

• Council Directive 93/36/EEC coordinating procedures for the award of public supply contracts (Supplies Directive); and

• Council Directive 92/50/EEC relating to the coordination of procedures for the award of public service contracts (Services Directive).

A parallel set of rules is set out in the following directive (“utilities directive”), which coordinates the procurement procedures of entities operating in the water, energy, transport and telecommunications sectors. The utilities directive applies to procurement by utilities which are in the public sector or which, if in the private sector, carry out the specified activity on the basis of “special or exclusive rights”:

• Council Directive 93/38/EEC coordinating the procurement procedures of entities operating in the water, energy, transport and telecommunications sectors (Utilities Directive),

together, with the public directives, the “procurement directives”.

It should be noted that the procurement directives are mutually exclusive, meaning that no one contract can be subject to more than one procurement directive.

The core requirements of the above directives are:

• specific rules governing the tendering procedures that can be used by public bodies falling within the scope of the rules;

• rules on selection of bidders, specification of contracts, and award procedures; and

• effective remedies where the above rules are not followed, to allow disappointed bidders to assert their rights.

The application of the procurement directives is summarised below, followed by a more detailed consideration of the award procedures required by the directives.

10.2.2.1 Application of procurement directives to Galileo

10.2.2.1.1 Parties

The public directives only apply to contracts placed by “contracting authorities”. “Contracting authorities” are defined as “…the State, regional or local authorities, bodies governed by public law, associations formed by one or several such authorities or bodies governed by public law”. The key element of this definition is the existence of State control or influence. The term “contracting authority” was considered in Case 31/87 Gebroeders Beentjes NV v Netherlands [1988] ECR 4635, which stated that it was a body whose composition and functions are laid down by legislation and which depends on the authorities for the appointment of its members, the observance of obligations arising out of its measures and the financing of public contracts which it is its task to award. Based on this description, the JU (and presumably its successor, the Galileo public authority) are likely to constitute a “contracting authority” for the purposes of the procurement directives being a body established for the specific purpose of meeting needs in the general interest and financed for the most part by the State. Works, supply and service contracts may be caught by the public directives. The identity and legal personality of the Galileo public authority will be central to determining which national as well as EU rules apply to it.

LN1:#20065849 140 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 141 The utilities directive only applies to contracts placed by “contracting entities”. “Contracting entities” are defined as public authorities or undertakings that exercise one of the activities set out in article 2(2) of the utilities directive. Since one of these activities include telecommunications services (see section 10.2.2.8), some Galileo services may be caught by the utilities directives to the extent that the contracting authority owns or operates telecommunications networks or services. It will only be possible to analyse the precise impact of the utilities directive when the nature of the Galileo public authority and the ownership structure of Galileo is determined.

The procurement directives apply to contractors who are nationals of and established in relevant states (being Member States, Norway, , Liechtenstein, Hungary and Poland). It is likely that potential bidders will come from these states. It should be noted that the rules of the EC Treaty on rights of establishment and the free movement of services are liberal, so that companies established within the EU territory are entitled to benefit from the rules on free movement of goods and services and free competition even if their ownership is non-EU.

10.2.2.1.2 Thresholds

The procurement rules will only apply where the public authority or utility (“awarding authority”) intends to award a contract of more than a specified value. The value thresholds are:

• EUR 5,000,000 for all works contracts (construction and civil engineering);

• EUR 139,300 for supplies and services contracts awarded by central government and other authorities covered by the GPA;

• EUR 200,000 for supplies and service contracts that are put out to tender by other public sector bodies (e.g. local government);

• EUR 400,000 for supplies and service contracts that are put out to tender by utility companies other than telecommunications operators; and

• EUR 600,000 for supplies and service contracts that are put out to tender by telecommunications operators.

Where a single transaction involves more than one contract the estimated value of all the contracts must be aggregated in deciding whether the threshold is reached. Where the threshold is reached each of the contracts will be covered by the rules other than small contracts (known as small lots) whose value falls below the de minimis level provided for in the Regulations.

The procurement rules will not apply where these value thresholds are not met. Nevertheless, it should be noted that awarding authorities are still bound by the provisions of the EC Treaty where they apply, and by a general obligation under the EC Treaty not to discriminate on grounds of nationality, even where the contract in question falls outside the procurement directives.

10.2.2.1.3 General exclusions

Each of the procurement directives sets out a list of exclusions, the principal of which are as follows:

• defence contracts;

• secret or security contracts;

LN1:#20065849 141 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 142 • contracts governed by different international procedural rules; and

• contracts pursuant to international agreements or particular procedures of international organizations.

Therefore, for example, Galileo contracts relating to defence or security, will not be subject to the EU procurement regime.

The first two to four satellites will be launched during the development and validation phase of the Project and will be procured and launched by ESA on behalf of the Joint Undertaking. Hence, ESA's own procurement rules387 will be applicable to these satellites and such procurement will fall within the last exclusion listed above. There may also be advantages (e.g.: due to the availability of tax exemptions) in ESA continuing to procure satellites during the deployment phase of the project, in which case the ESA procurement rules would continue to be applicable.

10.2.2.1.4 Exclusions from the Procurement Directives

In addition to the standard exclusions (e.g. projects certified as secret and contracts entered into pursuant to the procedures of international organisations) there are a number of exclusions from the procurement rules as a whole. These include employment contracts, contracts for land, for arbitration and conciliation services, for certain telecommunications services (see section 10.2.2.1.5 below) and for certain research and development services.

Contracts are also excluded, subject to certain conditions, for:

• activities other than relevant activities;

• the carrying out of activities outside the EC;

• the acquisition of goods, works or services for competitive resale;

• the purchase by water utilities of water, and by energy utilities of energy or fuel for the production of energy;

• in connection with the provision of bus services in areas where others are free to provide those services under substantially the same conditions; and

• exclusively in relation to the provision of telecommunications services in areas in which others are free to provide those services under substantially the same conditions.

10.2.2.1.5 Possible exclusion of “satellite services”

The Utilities Directive contemplates that the EC can exempt certain services from the application of the public procurement rules where a real competitive market situation has developed, for example through the introduction of effective liberalisation. On 12 May 1999, the EC agreed a list, whereby “satellite services” in certain geographical areas388 are exempted from the scope of the Utilities Directive due to the recent liberalisation of the telecommunications market389. Whilst to some extent the exemption could be applicable to Galileo, we have significant doubts in this regard, since a substantial part of the service to be provided by Galileo will be utilised in markets other than telecommunications. Whilst

387 These rules are available on the ESA website (www.esa.int). 388 Including Belgium, Denmark, Germany, Spain, France, , Italy, Netherlands, Austria, Portugal, , Sweden and the UK. 389 See “Commission agrees list of telecommunications services exempted from public procurement rules (12 May 1999)” on EU website (http://europa.eu.int).

LN1:#20065849 142 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 143 exemption under the Utilities Directive is arguable, this does not rule out the applicability of one of the other Procurement Directives.

10.2.2.2 Public Works Contracts

Public works contracts are contracts for the carrying out of civil engineering or building works, or under which a purchaser engages a person to procure by any means the carrying out for the purchaser of a work corresponding to specified requirements.

Which award procedures may be used?

The open procedure or the restricted procedure390 should normally be used.

However, the negotiated procedure with a call for competition may exceptionally be used when the work or works are to be carried out under the contract purely for the purposes of research, experiment or development, but not where the works are to be carried out to establish commercial viability or to recover R&D costs; or where the nature of the work or works, or the risks involved, are such as not to permit prior overall pricing. The circumstances in which the negotiated procedure can be used without a call for competition include cases where for technical or artistic reasons, or for reasons connected with the protection of exclusive rights, the contract can only be carried out by a particular person. In such circumstances the negotiated procedure without a call for competition may be used.

Publication of notices in the OJ and deadlines for responses

A prior information notice (PIN) must be sent to the OJ as soon as possible after the decision approving the planning of the work or works.

Contract notices should be sent to the OJ as follows:

Open procedure allowing not less than 52 days from despatch, or 36 days where a PIN has been published, for responses.

Restricted procedure allowing not less than 37 days from despatch (or 15 days in cases of genuine urgency) for requests to be selected to tender. After invitations to tender have been issued a minimum of 40 days, or 26 where a PIN has been published, (or 10 days in cases of urgency) should be allowed for receipt of tenders.

Negotiated procedure allowing not less than 37 days from despatch (or 15 days in cases of genuine urgency) for requests to be selected to negotiate.

A contract award notice should be sent to the OJ no later than 48 days after a contract has been awarded.

10.2.2.3 Public Works Concession Contracts

Public works concession contracts are public works contracts under which the consideration given by the public authority consists of or includes the right to exploit the work or works to be carried out under the contract. Depending upon the ultimate procurement route adopted, this type of contract could be applicable to the Galileo concession package proposed to be tendered. However, we are of the view that Galileo is a service orientated project and the concession, depending upon its ultimate structure is more likely to be viewed as a public service contract (see Section 10.2.2.5 below).

Publication of notices in the OJ and deadline for responses

390 For a description of the three procedures (open, restricted and negotiated), see 5.3 below.

LN1:#20065849 143 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 144 Contract notices should be submitted to the OJ allowing not less than 52 days from despatch for responses from potential concessionaires.

Other relevant issues

Expressions of interest cannot be rejected on grounds of nationality but there is no requirement for a competition to be held.

The winning concessionaire is required to comply with certain OJ advertising requirements in relation to works contracts which it intends to award to third parties (i.e. other than to affiliated undertakings) allowing minimum periods for responses:

• 40 days from dispatch, where a notice invites tenders; and

• 37 days from dispatch, where a notice invites applications to be selected to tender or to negotiate the contract, and a further 40 days between invitation to tender and the deadline for the receipt of tenders.

10.2.2.4 Subsidised Works Contracts

Subsidised works contracts are contracts for certain types of works which are awarded by a body other than another public authority, where a public authority undertakes to contribute more than half the consideration. Works contracts awarded by the Concessionaire to sub- contractors may fall into this category.

Requirements

The types of work are civil engineering activities, building work for hospitals, facilities intended for sports, recreation and leisure, school and university building or buildings for administrative purposes. The public authority awarding the grant is obliged to require the subsidised body to comply with the Regulations, as if it were a public authority, as a condition of grant. There is a similar requirement for subsidised service contracts in connection with subsidised works

10.2.2.5 Public Services Contracts

A public services contract is a contract under which a contracting authority engages a person to provide services other than a service concession contract.

Categories of service

Services are divided into two categories:

• Part A - to which the full rules apply; and

• Part B - where the only obligations relate to technical specifications and post-award information.

Therefore there is no requirement in the EC rules for contracts for Part B services to be subject to competition.

Which award procedure may be used?

The open or restricted procedure should normally be used. However, the negotiated procedure with a call for competition may be used:

(a) exceptionally, when the nature of the services to be provided, or the risk involved, are such as not to permit overall pricing; or

LN1:#20065849 144 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 145 (b) when the nature of the services to be provided is such that specifications cannot be drawn up with sufficient precision to permit the use of the open or restricted procedure.

Clearly, if the procurement of the Galileo system were to be made pursuant to regulations promulgated under the Services Directive, then the exception described in (b) above would enable the negotiated procedure to be utilised.

Exceptions from the requirement for competition

The circumstances in which the negotiated procedure can be used without a call for competition are set out in the Regulations. These include:

• contracts where for technical or artistic reasons, or for reasons connected with the protection of exclusive rights, the services to be provided may only be provided by a particular person; and

• where the rules of a design contest require the contract to be awarded to the successful contestant or one of the successful contestants if all are invited to negotiate it.

Publication of notices in the OJ and deadlines for responses

A prior information notice (PIN) is required to be sent to the OJ, as soon as possible after the start of an authority’s financial year, for Part A services coming within the scope of the Regulations in respect of each category of service for which the total requirement for the year is expected to exceed EUR 750,000.

Contract notices should be sent to the OJ as follows:

Open procedure allowing not less than 52 days from despatch, or 36 days where a relevant PIN has been published, for responses.

Restricted procedure allowing not less than 37 days from despatch (or 15 days in cases of urgency) for requests to be selected to tender. After invitations to tender have been issued a minimum of 40 days, or 26 where a PIN has been published, (or 10 days in cases of urgency) should be allowed for receipt of tenders.

Negotiated procedure allowing not less than 37 days from despatch (or 15 days in cases of urgency) for requests to be selected to negotiate.

A contract award notice must be sent to the OJ no later than 48 days after a contract has been awarded. For Part B services the purchaser can say whether the notice is to be published.

10.2.2.6 Public Service Concession Contracts

A public service concession contract is a contract under which a public authority engages a person to provide services to the public lying within its responsibility and under which the consideration given by the public authority consists of or includes the right to charge the public for the services.

Application of the EC procurement rules

The EC Directives do not apply to the award of service concession contracts. Therefore there is no EC requirement for competition. However, there is a provision in the Supplies Directive which applies when a public authority grants to a person other than a public authority special or exclusive rights to carry on a service for the benefit of the public. The public authority is required to impose an express condition on that person that in awarding its own supplies contracts it is not to discriminate on grounds of nationality, against a person who is a national

LN1:#20065849 145 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 146 of and established in a Member State, or on the grounds that the goods to be supplied under the contract originate in another Member State.

10.2.2.7 Public Supply Contracts

A public supply contract is a contract for the purchase or hire of goods and for any siting or installation of those goods.

Which award procedure may be used?

The open procedure or the restricted procedure should normally be used. The negotiated procedure may only be used in exceptional circumstances.

Exceptions from the requirement for competition

The circumstances in which the negotiated procedure may be used without a call for competition include: a) goods manufactured purely for the purpose of research, experiment, study or development but not where the goods are to be purchased or hired to establish their commercial viability or to recover their research and development costs; and b) where for technical or artistic reasons, or for reasons connected with the protection of exclusive rights, the goods to be acquired may only be manufactured or supplied by a particular person.

Publication of notices in the OJ and deadlines for responses

A prior information notice (PIN) is required to be sent to the OJ as soon as possible after the start of an authority’s financial year in respect of contracts coming within the scope of the Regulations where the total consideration which the authority expects to give under all such contracts for a particular product area is EUR 750,000 or more.

Contract notices should be sent to the OJ as follows:

Open procedure allowing not less than 52 days from despatch for responses.

Restricted procedure allowing not less than 37 days from despatch (or 15 days in cases of urgency) for requests to be selected to tender, After invitations to tender have been despatched a minimum of 40 days (or 10 days in cases of urgency) should be allowed for receipt of tenders.

Negotiated procedure allowing not less than 37 days from despatch (15 days in cases of urgency) for requests to be selected to negotiate.

A contract award notice should be sent to the OJ no later than 48 days after a contract has been awarded.

10.2.2.8 Utilities Contracts

The definitions for utilities contracts are the same as those for public authorities’ contracts with the following exceptions:

• there is no distinction between works contracts and works concession contracts, and the latter should therefore be treated as works contracts;

LN1:#20065849 146 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 147 • contracts for financial services in connection with the issue, sale, purchase or transfer of securities or other financial instruments and central bank services are not excluded from the Utilities Regulations ; and

• there is no exclusion for broadcasting time or material. Service contracts are divided into Parts A and B, as for public authorities; and there is no requirement in the EC rules for contracts for Part B services to be subject to competition. Service concession contracts as defined in section 10.2.2.6 are also excluded.

There is specific provision for framework agreements to be treated as if they were contracts.

Provided an agreement is awarded in accordance with the rules, there is no need for a further call for competition when individual contracts are awarded.

Coverage

The rules apply to:

• public authorities;

• public undertakings (undertakings over which public authorities may exercise directly or indirectly a dominant influence) ; and

• private sector bodies which operate on the basis of special or exclusive rights or which are deemed to do so; if they undertake relevant activities.

The relevant activities are:

• the provision or operation of fixed networks for the provision of services to the public in connection with the production transport or distribution of drinking water, electricity or gas or heat;

• the supply of drinking water, electricity, gas or heat to such networks;

• sewerage and hydraulic engineering activities by water network operators;

• the exploitation of a geographical area for the exploring for, or extracting of, oil, gas, coal or other solid fuels

• the exploitation of a geographical area for the provision of airport, maritime or inland port facilities;

• the operation of networks providing transport services to the public by rail, tramway, trolley-bus, bus, cable or automated systems; and

• the provision or operation of telecommunications networks or the provision of telecommunications services.

10.2.3 AWARD PROCEDURES

The procurement directives provide for three types of procedure for awarding public contracts: the open procedure, the restricted procedure, and the negotiated procedure. In the utilities sector, the contracting authority enjoys a greater degree of flexibility and is entitled to a free choice between these three procedures provided that there is a prior call for competition. The requirement for there to be a call for competition will be satisfied by the following:

LN1:#20065849 147 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 148 • If an indication of an intention to award the contract has been set out in a prior PIN;

• If a notice indicating the existence of a qualification system for bidders has been sent to the OJ; or

• If a contract notice has been sent to the OJ.

The public sector, however, is subject to the following rules in relation to which procedure may be used.

10.2.3.1.1 Open Procedures

An open procedure is one where all interested bidders may submit tenders in response to a published contract notice. This is generally most suitable where both the subject matter of the contract and the award criteria are fairly simple. It is therefore unlikely to be appropriate for Galileo.

10.2.3.1.2 Restricted Procedures

In a restricted procedure, only those suppliers invited by the awarding authority may submit tenders. Once tenders have been submitted, post-tender negotiations are generally not permitted (although clarification of tenders is permissible). The dividing line between negotiation and mere clarification is not clear-cut, but it appears that discussions on fundamental issues, particularly price are rules out.

10.2.3.1.3 Negotiated Procedures

A negotiated procedure is one where the contracting authority consults the bidders of its choice and negotiates with them the terms of the contract, e.g. the technical, administrative or financial conditions. It is likely that this procedure will be the most appropriate one for Galileo.

In a negotiated procedure, the applicable directive enables the contracting authority to act flexibly not only at the time it awards the contract but also during the prior discussions. The procedure is not, however, to be equated with private contracting. It requires the contracting authority to play an active role in determining the terms of the contract, with special reference to prices, delivery deadlines, quantities, technical characteristics and guarantees.

Nor does the procedure relieve the contracting authority of the obligation to comply with certain rules of good administrative practice. In other words, the contracting authority must:

• compare effectively tenders and the advantages they offer; and

• apply the principle of equal treatment between competitors.

Utilities may use the negotiated procedure without restriction provided that a call for competition has been made. However, public contracting authorities may only use it in exceptional circumstances (such as where there is no response to an open procedure, cases of extreme urgency or where articles are manufactured purely for research purposes). Since these constitute derogations from the rules of the public directives, which are designed to ensure that firms competing for contracts can effectively rely on the rights conferred on them by the EC Treaty, they must be interpreted strictly and the burden of proving the actual existence of exceptional circumstances justifying a derogation lies with the contracting authority seeking to rely on those circumstances.

According to circumstances, the negotiated procedure may be used with or without prior publication of a contract notice in the OJ in accordance with the applicable directive.

LN1:#20065849 148 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 149 Negotiated procedures with prior publication of a contract notice

In this procedure, the contracting authority has to select the candidates it invites to take part in the negotiated procedure from among those presenting the qualifications specified in the notice. Such qualifications must relate exclusively to the bidder’s personal standing and financial, economic and technical capacity.

Public contracts may be awarded by negotiated procedure with prior publication of a contract notice where an open or restricted procedure has elicited only irregular tenders or tenders which are unacceptable under certain provisions (the Common rules on participation; Criteria for qualitative selection; and Criteria for the award of contracts). In this case, the negotiated procedure may be used only if the original terms of the contract, as specified in the tender notice and contract documents, are not substantially altered.

Otherwise, the open or restricted procedure has to be started again from the beginning in full compliance with the provisions of the Directive applicable to each of the procedures. For instance, changes in the financing conditions, the deadlines for delivery or the technical specifications identifying the products to be supplied are to be regarded as substantial alterations to the original terms of the contract.

Furthermore, a public contracting authority may legitimately resort to the negotiated procedure only where it has issued a prior official statement that the tenders received during the preceding open or restricted procedure were irregular or unacceptable, and has declared that procedure closed.

Prior publication of a contract notice is not required where contracting authorities include in the negotiated procedure all bidders who satisfy the qualitative selection criteria and who submitted during the earlier open or restricted procedure tenders complying with the formal requirements of the tendering procedure.

Negotiated procedures without prior publication of a contract notice

The negotiated procedure without prior publication of a contract notice may be used in the following exceptional cases:

(a) where no tenders or appropriate tenders are received in response to an open or restricted procedure, in so far as the terms of the contract established for that procedure are not substantially altered during the negotiated procedure and provided that the contracting authority submits a report to the EC setting out all the information required to prove that these circumstances are met;

"Inappropriate tenders" means not only unacceptable or irregular tenders, but also tenders which are completely irrelevant to the contract and are therefore incapable of meeting the contracting authority’s needs as specified in the contract documents. Such tenders are consequently regarded as not having been submitted;

(b) where the articles involved are manufactured purely for the purposes of research, experiment, study or development. This provision does not extend to quantity production to establish commercial viability or to recover R&D costs; nor does it cover capital goods purchased for research or experimental laboratories;

(c) where, for technical or artistic reasons or for reasons connected with protection of exclusive rights, the goods supplied can be manufactured or delivered only by a particular supplier.

This rule therefore lays down two conditions, both of which must be proven to be satisfied: the goods must have special technical or artistic features or must be protected by exclusive rights, and there must be only one potential supplier.

LN1:#20065849 149 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 150 (d) in so far as is strictly necessary when, for reasons of extreme urgency brought about by events that could not be foreseen by the contracting authority, suppliers cannot be allowed the periods laid down for open or restricted procedures, or for a negotiated procedure with prior publication of a notice, including accelerated procedures – whether restricted or negotiated. The circumstances invoked to justify extreme urgency must not in any event be attributable to the contracting authority.

10.2.3.1.4 Notices

Indicative notice

The purpose of this notice is to make contracting authorities’ procurement programmes known to potentially interested bidders.

Contracting authorities must, as soon as possible after the beginning of their budgetary year, make known by means of an indicative notice the total procurement by product area which they intend to award during the subsequent 12 months.

This form of advertising is mandatory where the total amount by product area, equals or exceeds EUR 750 000.

Product areas must be established by reference to the headings in the CPA nomenclature.

The aim is to draw procurement programmes to the attention of potential bidders as soon as they are established and to enable firms – even those located furthest away from the contracting authority – to compete for contracts on an equal footing wherever possible.

Contract notice

A basic procedural requirement under all three award procedures (other that the negotiated procedure without prior publication of contract notice) is that the contract is brought to the attention of potential tenderers through the EU, who may then bid for the business on equal terms. This is achieved by the awarding authority sending a contract notice to the EC Office of Official Publications in Luxembourg who then publishes the contract notice in the “S” series of the OJ and on TED.

Contract award notice

Contracting authorities which have awarded a contract must, irrespective of the procedure used, publish a contract award notice setting out the most important points concerning the conditions in which the contract has been awarded. Contract award notices are intended not only to ensure greater transparency in award procedures but also to generate more interest among bidders in the Community and encourage more of them to take part in award procedures.

10.2.3.1.5 Information Concerning The Contracting Authority’s Decision

Rejection of applications and tenders

Any eliminated candidate has the right to ask the contracting authority for the reasons for his rejection, and any tenderer whose bid has been rejected has the right to ask for the reasons and for the name of the successful tenderer.

The contracting authority must provide the information requested within fifteen days of receiving the request.

Contract report

LN1:#20065849 150 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 151 For each contract awarded, contracting authorities are obliged to draw up a report, which must contain at least the following information:

• the name and address of the contracting authority, the subject and value of the contract;

• the names of the candidates or tenderers selected, with reasons;

• the names of the candidates or tenderers rejected, with reasons; and

• the name of the successful tenderer and the reasons why his tender was chosen and, if known, any share of the contract which the tenderer intends to subcontract to third parties;

• for negotiated procedures, the circumstances justifying the use of the procedure. The circumstances may, of course, be only those provided for in the Directive.

This report, or the main features of it, must be communicated to the EC at its request.

10.2.3.1.6 Content and Presentation of Notices

Contracting authorities are required to draw up notices in accordance with the prescribed forms, giving the information specified in the relevant form.

Where the items are mandatory, the information required must be given. Where they are optional and not relevant to the contract in question, the contracting authority should indicate the fact, by entering "not applicable" or words to that effect.

In the section concerning the criteria to be used for awarding the contract, the contracting authority must enter either:

• "the lowest price", or

• "the most economically advantageous tender", or

• where it is using the restricted procedure and specifies the award criteria in the invitation to tender, "award criteria specified in the invitation to tender", or words to that effect.

Where the contracting authority indicates that it will award the contract to "the most economically advantageous tender", it must specify the factors that will be taken into consideration either in the same section of the notice or in the contract documents. In the latter case, it must add in that section of the notice the words "award criteria stated in the contract documents".

While conveying clear and comprehensive information, notices must be concise: they must not run to more than one page of the Official Journal, or approximately 650 words

10.2.3.1.7 Pre-selection of bidders

The suitability of bidders must be checked not only in open, but also in restricted and negotiated procedures. Contracts must be awarded on the basis of the prescribed criteria after the suitability of bidders has been checked. Contracting authorities must base such checks on the criteria of economic, financial and technical capacity of the bidders.

However, a favourable verdict does not have the same consequences in the three procedures.

LN1:#20065849 151 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 152 In open procedures, compliance with the predetermined selection criteria gives the tenderers concerned an automatic right to participate in the award procedure. The contracting authority will, therefore, be obliged to examine all bids from such tenderers.

In restricted and negotiated procedures, however, candidates who satisfy the predetermined selection criteria may be excluded from the procedure, since contracting authorities, subject to certain conditions, may limit the number of candidates they invite to tender or negotiate and, therefore, may effect a choice.

Consequently, when examining tenders, contracting authorities may not, for example, allow themselves to be influenced by the tenderer’s financial capacity or give a tenderer who has not satisfied the pre–established selection criteria a second chance because they deem his tender advantageous.

Contracting authorities are under the further obligation to respect fully the confidential nature of any information furnished by candidates or tenderers.

Selection and number of candidates invited to submit a tender or to negotiate

Suppliers invited to submit a tender may be selected only from among those who have requested to participate in the procedure and display the qualifications required for that procedure; those qualifications may be based only on the criteria for qualitative selection.

"In restricted and negotiated procedures the contracting authorities shall, on the basis of information given relating to the bidder’s personal position as well as to the information and formalities necessary for the evaluation of the minimum conditions of an economic and technical nature to be fulfilled by him, select from among the candidates with the requisite qualifications those whom they will invite to submit a tender or to negotiate".

Contracting authorities are not obliged to invite all candidates to bid who meet the requirements of the contract. Those who are invited, however, must all satisfy such conditions and may be chosen by the contracting authority only on the basis of these qualitative selection criteria, which must be transparent and objective and laid down in advance.

Contracting authorities may, therefore, limit the numbers of those invited to tender or negotiate only by taking into consideration the candidates with the best qualifications in accordance with the selection criteria specified in the contract notice.

In order to be able to invite fewer candidates than those who meet the requirements of the contract, contracting authorities must have previously stated in the contract notice the proposed number, or range, of bidders who will be invited to tender or negotiate.

Where this has not been stated, they may not eliminate any of the candidates who have submitted correct applications and possess the requisite qualifications.

In restricted procedures, the range encompassing the number of candidates who will be invited to tender must be determined with reference to the nature of the supplies to be provided.

Having determined a minimum number in advance in accordance with the applicable procurement directive, a contracting authority could find itself unable to stick to that number because it had received too few applications from sufficiently qualified bidders. In that eventuality, it can be considered that there is genuine competition where at least three candidates are invited to tender, assuming that sufficient applications to take part were received from eligible bidders.

LN1:#20065849 152 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 153 In negotiated procedures with prior publication of a contract notice, the minimum number of candidates invited to negotiate may not be less than three, on condition, of course, that there are sufficient suitable candidates.

Inviting nationals from other Member States

In any event, where candidates are invited to tender under a restricted or negotiated procedure, the contracting authorities are required - to issue invitations, without discrimination, to bidders in other Member States who satisfy the necessary requirements, and to do so under the same conditions as apply to domestic bidders.

In this respect, it can be presumed as a general rule that there is no discrimination on grounds of nationality when bidders are selected if, in its selection, the contracting authority maintains the same proportion between domestic candidates and those from other Member States as that observed among candidates with the requisite qualifications. If a check is made, however, such a presumption will be without prejudice to a more detailed assessment of the information taken into account at the selection stage.

10.2.3.1.8 Rules governing the dispatch and content of invitations to tender

ITTs must be made in writing and sent simultaneously to all selected candidates.

The letter of invitation should normally be accompanied by the contract documents and supporting documents and include at least the following information:

(a) where it is not accompanied by the contract documents and supporting documents, which the contracting authority does not have since they are the responsibility of another department, the address of the department from which they may be requested, the deadline for submitting such a request and the amount and terms of payment of any charge for obtaining such documents;

(b) the closing date for the receipt of tenders, the address to which they must be sent and the language(s) in which they must be drawn up;

(c) a reference to the published contract notice;

(d) an indication of any documents to be attached, either to support verifiable statements made, or to supplement the information provided by the candidate to show that he meets the selection criteria; and

(e) the criteria for the award of the contract, if not stated in the contract notice.

Where the accelerated form of restricted or negotiated procedures is used, the Directive requires contracting authorities to send out invitations to tender by the most rapid means of communication possible.

10.2.3.1.9 Award criteria

The authority must ultimately select the bidder who puts forward the “most economically advantageous” offer. This concept equates broadly to “best value for money” and criteria (e.g. technical merit, time for completion, functional qualities and price) will have been specified in the contract notice or contact documents.

10.2.3.1.10 Typical breaches of procurement rules

Typical breaches include:

LN1:#20065849 153 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 154 • Authority fails to advertise the relevant contract in OJ, possibly on the basis of incorrect classification of the contract;

• Authority artificially sub-divides large contracts into smaller lots to bring value under threshold;

• Authority uses non-objective criteria in selecting supplier, whether at qualification or award stage;

• Authority fails to specify criteria in advance or does so but then changes them or applies them in an unfair way;

• Authority lays down technical specifications or standards which discriminate against certain suppliers, for example, because national (rather than European standards) are used;

• Authority fails to respect duty to treat all tenderers equally; and

• Authority fails to give adequate reasons for its rejection of particular bidder upon request.

10.2.4 REMEDIES FOR BREACH

The procurement rules are backed-up by the following directives (“Remedies Directives”) which deal specifically with remedies for breach of the procurement rules:

• Council Directive 89/665/EEC on the co-ordination of the laws, regulations and administrative provisions relating to the application of review procedures to the award of public supply and public works contracts

• Council Directive 92/13/EEC co-ordinating the laws, regulations and administrative provisions relating to the application of community rules on the procurement procedures of entities operating in the water, energy, transport and telecommunications sectors

The Remedies Directives require each Member State to ensure391 that effective remedies and means of enforcement are made available in respect of any infringement of the procurement rules.

An aggrieved party potentially has access to some or all of the following remedies:

• Interim measures392;

• Dissuasive penalty payments393;

391 This is achieved through national implementing measures. However, even in the absence of implementation in some countries, aggrieved parties should be able to rely upon the directly effective nature of the provisions in the remedies directives in order to seek redress. 392 Where there has been a breach of Community law by a Member State, the ECJ has powers to grant interim remedies or to order that the contract is not to be performed For example, UK Regulations give effect to these provisions by (i) providing for relevant suppliers to bring proceedings against the purchaser before the High Court in England and , the High Court in or the Court of Session in Scotland. They provide for injunctive relief and/or damages, but with damages to be the only remedy if the contract has been entered into and (ii) imposing an obligation on purchasers to provide information needed for the purpose of responses to the EC.

LN1:#20065849 154 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 155 • Damages394;

• Intervention by the EC395; and

• Alternative Dispute Resolution396.

In addition to the above remedies, it should be borne in mind that the EC Treaty itself forms part of the national laws of the Member States. Articles 28 et seq. and Articles 42 and 49 et seq. of the EC Treaty confer rights on individuals and companies that can be enforced or relied on in the national courts against inconsistent national law. Damages for breach of EC law is in general only available where there has been a “sufficiently serious breach” of such a rule, involving a manifest disregard for the limits on the discretion of a public body, but the possibility of such an action against a Member State or the Community cannot be ruled out.

10.2.5 FUTURE DEVELOPMENTS IN EU PROCUREMENT LAW

The EC has adopted a package of amendments to simplify and modernise the public procurement directives.

The legislative package adopted397 has two objectives. The first is to simplify and clarify the existing EU procurement directives, and the second is to adapt them to modern administrative needs in a changing economic environment. The legislative package also includes measures designed to make for greater clarity in the criteria determining the award of the contract and the selection of tenderers.

Simplification: making the texts clearer and more comprehensible

Simplification is an essential feature of the legislative package. The aim is to make the Directives easier to understand for everybody who is involved in public procurement, either as a buyer or as a supplier. The following examples illustrate this simplification effort:

• The three old Directives, covering supplies, services and works, are to be consolidated and recast in a single coherent text, which should make it possible to reduce the number of articles by nearly a half.

• The new provisions are presented in a more user-friendly manner: they have been set out in such a way as to reflect the normal order of an award procedure.

• The new structure and the new provisions are designed to guide users through all the stages of the award procedure.

• The thresholds which determine the application of the new instruments are also to be simplified and will be expressed in euros instead of special drawing rights.

393 This only applies to utilities and has only been taken up by three member states (France, Denmark and Luxembourg) 394 This remedy varies according to the Member State, but typically a claimant seeking damages must prove that (i) the awarding authority has committed an infringement of the procurement rules (ii) the claimant has suffered harm or loss and (iii) there is a direct causal link between the breach and the harm or loss. 395 The EC can invoke a “corrective procedure” whereby they call upon an awarding authority to justify its conduct, rectify an infringement or suspend the award procedure. 396 This should be less expensive than litigation. 397 See (i) Proposal for a Directive of the European Parliament and of the Council on the coordination of procedures for the award of public supply contracts, public services contracts and public works contracts dated 10 May 2000 and (ii) Proposal for a Directive of the European Parliament and of the Council coordinating the procurement procedures of entities operating in the water, energy and transport sectors dated 10 May 2000. Note these proposals to not set specific target dates for implementation of the proposed amendments.

LN1:#20065849 155 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 156 Modernisation and flexibility: award procedures adapted to the needs of a modern administration and the new economy

One of the recurring demands during the consultations conducted by the EC in preparing the proposals it has adopted was the modernisation of award procedures to adapt them to the administrative requirements of the 21st century. The new proposals accordingly relax some of the provisions which were considered too inflexible to achieve the objective of best value for money. The following examples illustrate the adjustments proposed:

• For complex contracts, new procurement arrangements would allow a "dialogue" between awarding authorities and tenderers to determine the contract conditions; the new procedure would offer guarantees that the principles of transparency and equal treatment would not be adversely affected by this "dialogue".

• In order to enable administrations to benefit from economies of scale flowing from a long- term procurement policy and to guarantee security of supply and the necessary flexibility for recurring purchases, the new proposals are more flexible in the approach to standard- form contracts.

• Public-sector buyers would enjoy more flexibility in defining the purpose of the contract: under the new provisions public-sector purchasers could specify their requirements in terms of performance and not only in terms of standards.

Modernisation also means adjusting procedures to an economic environment that is changing. Although the present directives were updated in the 1990s, they do date back to the 1970s. A response was therefore needed to changes resulting from things such as the information technology revolution or the liberalisation of telecommunications. The following examples illustrate this modernisation:

• The use of information technologies in public procurement is a vital factor in helping the public authorities to adapt to the changing environment and to make for more effective procurement. For this reason the legislative package is designed to encourage the public authorities to make greater use of electronic means, for instance by shortening the time taken to publish notices or the tendering period in certain circumstances.

• As a result of liberalisation and effective competition in telecommunications, the new provisions exclude this sector from the directive which used to apply to it.

10.3 WTO PROCUREMENT RULES

The Agreement on Government Procurement (GPA) was first negotiated during the Tokyo Round and entered into force on 1 January 1981. Its purpose is to open up as much of this business as possible to international competition. It is designed to make laws, regulations, procedures and practices regarding government procurement more transparent and to ensure they do not protect domestic products or suppliers, or discriminate against foreign products or suppliers.

The GPA is a plurilateral agreement with twenty-five members398. It has two elements — general rules and obligations, and schedules of national entities in each member country whose procurement is subject to the agreement. A large part of the general rules and obligations concern tendering procedures. It should be noted that the procurement directives have been amended to take account of the obligations of the EC and its Member States under the GPA.

398 Including the EC and its Member States, United States, Canada, Japan, South Korea, Israel, Switzerland and Norway.

LN1:#20065849 156 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 157 The present agreement and commitments were negotiated in the Uruguay Round. These negotiations achieved a ten-fold expansion of coverage, extending international competition to include national and local government entities whose collective purchases are worth several hundred billion dollars each year. The new agreement also extends coverage to services (including construction services), procurement at the sub-central level (for example, states, provinces, departments and prefectures), and procurement by public utilities. The new agreement took effect on 1 January 1996.

It also reinforces rules guaranteeing fair and non-discriminatory conditions of international competition. For example, governments will be required to put in place domestic procedures by which aggrieved private bidders can challenge procurement decisions and obtain redress in the event such decisions were made inconsistently with the rules of the GPA.

The GPA applies to contracts worth more than specified threshold values. For central government purchases of goods and services, the threshold is SDR 130,000 (some $178,000 in May 1997). For purchases of goods and services by sub-central government entities the threshold varies but is generally in the region of SDR 200,000. For utilities, thresholds for goods and services is generally in the area of SDR 400,000 and for construction contracts, in general the threshold value is SDR 5,000,000.

The GPA establishes an agreed framework of rights and obligations among its counterparties with respect to their national laws, regulations, procedures and practices in the area of government procurement. The cornerstone of the rules in the GPA is non-discrimination. In respect of the procurement covered by the GPA, governments counterparty to the GPA are required to give the products, services and suppliers of any other counterparty to the GPA treatment "no less favourable" than that they give to their domestic products, services and suppliers and not to discriminate among goods, services and suppliers of other counterparties (Article III:1). Furthermore, each counterparty is required to ensure that its entities do not treat a locally-established supplier less favourably than another locally-established supplier on the basis of degree of foreign affiliation or ownership and do not discriminate against a locally- established supplier on the basis of country of production of the good or service being supplied (Article III:2). In order to ensure that the basic principle of non-discrimination is followed and that access to procurement is available to foreign products, services and suppliers, the GPA lays heavy emphasis on procedures for providing transparency of laws, regulations, procedures and practices regarding government procurement.

Tendering procedures

The GPA contains a number of detailed procedural obligations which procuring entities have to fulfil to ensure the effective application of its basic principles (Articles VII to XVI). The purpose of these procedural requirements is to guarantee that access to covered procurement is effectively open and that an equal opportunity is given to foreign supplies and suppliers in competing for government contracts.

The GPA allows the use of open, selective and limited tendering procedures, provided they are consistent with the provisions laid out in Articles VII to XVI.

• Under open procedures all interested suppliers may submit a tender (Article VII:3(a)).

• Under selective tendering procedures only those suppliers invited to do so by the entity may submit a tender (Articles VII:3(b) and X). To ensure optimum effective international competition, purchasing entities are required to invite tenders from the maximum number of foreign suppliers. Safeguards to ensure that the procedures and conditions for qualification of suppliers do not discriminate against suppliers of other Parties are set out in Article VIII. For example, any conditions for participation in tendering procedures by suppliers shall be limited to those that are essential to ensure the firm’s capability to fulfil the contract and shall not have a discriminatory effect. Once a year the entities using the selective tendering method are required to publish, in a publication indicated in Appendix

LN1:#20065849 157 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 158 III to the GPA, their lists of qualified suppliers, and to specify the period of validity of those lists and the conditions that need to be met for inclusion of interested suppliers in the lists (Article IX:9).

• Under limited tendering procedures the entity contacts the potential suppliers individually (Article VII:3(c)). The GPA closely circumscribes the situations in which this method can be used, for example in the absence of tenders in response to an open tender or selective tender or in cases of collusion, when the product or service can be supplied only by a particular supplier, or for reasons of extreme urgency brought about by events unforeseeable by the entity (Article XV).

Entities may hold negotiations with suppliers making tenders, provided this is indicated in the initial tender notice or it appears from the tender evaluation that no one tender is the most advantageous and subject to safeguards to ensure that such negotiations do not discriminate between suppliers (Article XIV).

The GPA prescribes certain minimum deadlines that must be allowed for the preparation, submission and receipt of tenders to enable responsive tendering (Article XI:2). These must be set long enough to allow all suppliers, domestic and foreign, to prepare and submit tenders before the closing of the tendering procedures. In general the minimum shall be 40 days from the date of publication of an invitation to tender. The minimum time-limits for receipt of tenders may be reduced to 25 or even 10 days in certain well-defined circumstances.

In the tender documentation the purchasing entity is required to give all necessary information related to the procurement in question to enable potential suppliers to submit responsive tenders, including information required to be published in tender notices and other important information, for example economic and technical requirements, financial guarantees and the criteria for awarding the contract and procedural information such as the closing date and time for receipt of tenders (Article XII).

The objective of the procedural rules for submission, receipt and opening of tenders is to ensure fairness, equity and transparency in the procurement process (Article XIII:1-3). All tenders solicited under open and selective procedures by entities shall be received and opened under procedures and conditions guaranteeing the regularity of the openings.

Only tenders that conform to the essential requirements of the tender notice or documentation and are from a supplier which complies with the conditions for participation can be considered for award. Entities have the obligation to award contracts to the tenderer who has been determined to be fully capable of undertaking the contract and whose tender is either the lowest tender or the tender which is determined to be the most advantageous in terms of the specific evaluation criteria set forth in the notices or tender documentation. An entity that has received a tender abnormally lower than other tenders may enquire with the tenderer to ensure that it can comply with the conditions of participation and be capable of fulfilling the terms of the contract (Article XIII: 4).

The modes of transmission of data foreseen under the relevant provisions of the GPA are telex, telegram, facsimile. The GPA recognises the fact that its provisions do not take into account the rapidly emerging use of information technology in government procurement. In order to ensure that it does not constitute an obstacle to technical progress in this area, the GPA calls for regular consultations in the Committee regarding developments in information technology and, if necessary, negotiation of modifications to the GPA itself (Article XXIV:8).

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11 RECOMMENDATIONS AND CONCLUSIONS

The principal conclusions arising from our analysis of DFTS, Skynet 5, Inmarsat, UK NATS, NAV Canada, Toll Collect and Messina Straits Bridge are set out in this section.

As the Galileo concession contract is not yet available, please note that some of these conclusions and recommendations may prove not to be relevant or appropriate (for example, with regard to value for money challenges and the payment regime which might be put in place). Some recommendations will also be obvious (for example, the use of in-orbit spares) but are nonetheless included in this section as items which have emerged from these case studies.

11.1.1 GENERAL

1. In many cases the final forms of PPP Projects are not known when work begins. This may happen in relation to the Galileo concession contract as a result of negotiation with the selected bidder.

2. The Commission should be alert to the possibility that it may take longer to negotiate and conclude the concession than it expects. Many PPP transactions therefore take longer to complete than originally contemplated. For example, it took 15 years to achieve the PFI deal for the DFTS. When the preferred bidder for the Skynet deal was announced in February 2002, it was envisaged that final contract signature would take place by August 2002. However, as of June 2003, it still does not appear to have happened. The restructuring of Inmarsat began in 1990 and took nine years to achieve. Even in the year before it was completed, it was expected to be realised by 1 January 1999 and, in the event, that date slipped to mid-April 1999. The Messina Bridge project has been at the planning stage for a significant number of years. Conclusion: it takes more time than initially expected to conclude PPP projects. Consequently, fallback scenario(s) may need to be considered, for example regarding procurement and ownership of the satellites, which in the case of Galileo is already becoming a critical path matter if full deployment is to take place by 2008.

3. Consideration should be given to possible external constraints on the Galileo programme. Toll Collect has been delayed due to competition law issues, which should have been addressed much earlier in the programme within the original guidelines of the concession competition. In the case of the Messina Straits project, environmental issues and economic considerations have proved problematic. The solution is for the public sector to be clear on what its objectives are for Galileo and to ensure that the necessary legislative and regulatory structures are in place, at the latest, by the time the concession is scheduled to be awarded. Prior to award, bidders for the Galileo concession must have a clear indication as to how these matters will be addressed and this is indeed in the interests of the public sector, since without the required clarity, both equity and debt stakeholders will likely insist that any increased costs arising as a result of subsequent implementation of legislative and regulatory structures be covered by adjustments to Galileo’s economics (e.g.: perhaps through higher public availability and/or output payments).

4. The case studies indicate that almost invariably the costs of undertaking and implementing a complex PPP are higher than initially expected. The Commission should develop a budget strategy in the event that the costs of the concession are somewhat higher than it expects (bearing in mind the recommendation made in Section 11.1.4).

LN1:#20065849 159 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 160 11.1.2 QUESTIONS TO ASK

Set out below are examples of the questions which the MoD asks in evaluating PFIs. The Commission should note these items and put in place fallback strategies where the responses to the questions are “no”.

1. Will all existing or planned contracts within the scope of the project - or interfacing to it directly - be complete before the start of the new service?

2. Is there likely to be sufficient market interest to generate and sustain healthy competition throughout the procurement?

3. Does a significant market with sufficient capacity for these services exist in the private sector?

4. Does the nature of the deal and/or the strategic importance of the work and/or the prospect for further business suggest that it will be seen by the market as a potentially profitable venture?

11.1.3 EXTERNAL EXPERTISE

In view of the MoD’s Defence Procurement Agency (DPA) and the Defence Communications Services Agency (DCSA) unique and virtually unrivalled experience of PPP/PFI, the EC may wish to consult with the DPA and DCSA with regard to preparing the specific terms of the Galileo concession. It is critical to the achievement of an expeditious structuring, negotiation and execution of the Galileo project, that private sector specialists (financial, technical and legal) with the relevant experience and expertise are appointed at an early stage.

11.1.4 TENDER DOCUMENT

1. The EC, ESA and/or JU will need to consider the form of the document with which they seek bids for the concession, and whether they publish a full, detailed request for quotes (RFQ) or a request for proposals (RFP) which is less detailed and contains only the main points to be considered by bidders. In DFTS the MoD started with a so- called Cardinal Points Specification (CPS), which specified requirements but left open a number of possible technical solutions. The MoD provided a spreadsheet model with its estimates of the costs of operating the DFTS over the 10-year period and asked bidders to provide their own estimates of the costs based on the model. This could be a useful approach to be followed by the JU.

2. A cost model that supports sensitivity analysis is very useful to the tender assessment process. If they have not yet done so, the EC, ESA and/or JU should construct such a cost model in advance of the Galileo concession contract negotiations.

3. Funding technical studies to minimise the scope for bidders to price big premium risks may also be useful in the instance of Galileo. Whether it is useful will depend on what studies the ESA has not already performed. It will also depend on who wins the Galileo concession tender, as the winner may wish to fund such studies if it in turn tenders for the satellites. Apart from technical (technology) studies, there may be certain other studies to be undertaken by the bidders which the EC/ESA may find it useful to fund if there are two or more close bids for the concession.

4. The concession tender should be built on a set of contract terms developed by the EC/ESA/JU and their advisors. They should avoid a situation where they are

LN1:#20065849 160 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 161 negotiating terms which have been proposed by the bidders. Nevertheless, they should be open to suggestions from bidders which may help to maximise value for money.

5. After letting a contract, the EC should reassess the scope of the concession contract at periodic intervals during the contract period and prior to any further competition.

6. The EC/ESA/JU should reserve the right to modify the bidding process in any way which seems likely to improve value for money.

7. They should be careful to avoid asking for further rounds of bids as bidders are likely to anticipate this and take it into account when making their opening bids.

8. It goes without saying that competitive tension is the key to obtaining value for money from prospective bidders for the concession. The EC/ESA/JU may need to ensure there is genuine competition, the absence of which will greatly weaken their negotiating position.

9. Even after the concession is awarded, there will be a continuing need to manage the contract effectively to prevent the GOC from clawing back value. The EC should put in place an entity, like the MoD’s Integrated Project Teams, comprising some of those who negotiated the concession, to manage the concession contract.

10. The EC/ESA/JU should also consider making payments to the Galileo concessionaire based on availability and usage, and in stages, as the MoD is doing in the context of Skynet 5.

11. The EC/ESA may wish to consider a variable payment regime like that of the MoD for Skynet services, i.e., payments to the GOC would vary according to the service provided. Thus, for example, PRS service delivery might attract a higher payment than the open service.

12. The EC/ESA/JU should ensure it has an understanding of the risk management systems of bidders. The tender document should include provisions asking bidders to explain how they propose to manage risks. It should also include provisions for subsequent monitoring of the concessionaire’s risk management system/process.

11.1.5 INITIAL COMPETITION

The EC/ESA/JU may wish to supply bidders for the concession contract with a spreadsheet model of their estimates of the costs of operating Galileo, as the MoD did for the DFTS tender. The MoD asked bidders to provide their own estimates of the costs based on the MoD model, to ensure that bids were received in a consistent format to assist fair comparison.

11.1.6 AVOIDING MEMORY LOSS

At least some of those involved in negotiating the Galileo concession should be involved in the subsequent management of the contract in order to avoid “memory loss”, i.e., to ensure that the awareness of the specifics of the negotiations and the background behind certain provisions will be retained by the team which manages the contract. If there is uncertainty about what has led to particular agreements in the negotiations, then it increases the risk that the concession does not get off to a good start or that its ongoing operation is impaired. Avoiding memory loss should apply to both sides, the EC/ESA on the one hand and the concessionaire on the other.

LN1:#20065849 161 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 162 11.1.7 SECURITY

1. Although Galileo will have a security structure, the parameters of which will be established by the Galileo Security Board/Public Authority, the EC may wish to ensure that the provisions of the concession contract include something like the MoD’s Manual of Protective Security and its Code of Connection so that third party service providers and any other part of the Galileo infrastructure not under the direct control of the GOC are required to comply with certain security provisions and that there is an audit mechanism to check compliance.

2. It is unfortunate (but understandable) that it has not been possible to gather more information about the security structures which are or will be put in place for Skynet 5, as it would be useful to compare the MoD security structures or mechanisms with those envisaged for Galileo. The EC and/or GSB may wish to consider the utility of a higher level approach to the MoD to see if some “comparing of notes” would be possible. On the other hand, as the GSB is chaired by an MoD representative, it may well be that the GSB is already benefiting from MoD insights.

11.1.8 LEVELS OF DEMAND FOR SERVICES

1. The EC and/or JU should take note of the provision in the DFTS contract regarding minimum demand thresholds for certain services as something similar might apply if the Galileo concession fails to achieve revenue expectations on certain services, for example the public regulated service (PRS). The EC/JU will need to decide to what extent, if any, it will be prepared to fund any shortfall in revenues for particular services. At this stage the Galileo concessionaire is seen to have substantial revenue risk. Contrast the Toll Collect model, where Toll Collect assumes very little financial risk because the public sector underwrites its costs if revenues do not meet the required levels. For the public sector to underwrite the revenue risk for Galileo, there would have to be a clear set of pubic benefits associated with that investment.

2. By the same token, the EC/JU may wish to consider whether certain users (e.g. EU PRS users) could benefit from Galileo revenues exceeding specified expectations.

3. Both the Toll Collect and Messina Straits Bridge schemes allow or will allow for flexibility in relation to revenue risk. This could also be appropriate for the Galileo concession. For example, if revenues are not accrued, there could be a top-up payment by the public sector in the form of a PSSP. In return, if the revenues are substantial and cover operational costs, there could be a share of revenue gains once private sector debts are serviced. This would in turn reduce the level of risk for the concessionaire and increase the likelihood of a seamless investment plan by involving the public body in investment after the initial infrastructure contributions. An agreement like this would enable the public sector to use money collected from Galileo for future infrastructure projects, as is the case with the Toll Collect scheme.

11.1.9 CONTINUING COMPETITION

1. Consideration should be given to the Galileo concession contract including provisions regarding refreshing and/or upgrading services and technology. The EC/JU should ensure that its contract with the Galileo Operating Company has effective terms so that services are delivered as specified, and that incentives and flexibility are built into the contract terms to ensure that services do not become expensive or obsolete. Provision could also be made for increasing standards of service and technology over time.

LN1:#20065849 162 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 163 2. If the EC, ESA, GSB or others identify a new service requirement, the Galileo concession should include provisions by which they can request a proposal from the GOC. If they are not satisfied with the GOC’s proposals, they should be permitted to seek, so far as possible, service from another supplier in order to foster competition and to ensure that any proposal from the GOC delivers value for money. However, it is recognised that in practice it may be difficult to implement this recommendation since the services to be supplied by the concessionaire will most likely, at least at the highest level, only be available from one supplier, i.e., the concessionaire. However, it may be that at the next level down, among GOC service providers, there could be more competition for the supply of services.

11.1.10 THE RELATIONSHIP

1. Joint organisational structures are needed to manage and prioritise the evolution of the Galileo system. The importance of a close working relationship is essential to ensure a common vision and interpretation.

2. The JU/EC/ESA should consider creating the equivalent of an integrated project team (IPT), which would combine a multidisciplinary set of expertises, including those involved in negotiating and administering the Galileo concession. The IPT should either include representatives from whoever wins the concession or the IPT could form another committee with representatives from the concessionaire. In either scenario, the task of the IPT or joint committee would be to monitor on a regular basis the performance of the concession and to take those actions necessary to resolve any disputes, disagreements or problems arising.

3. The EC may wish to establish with the GOC a Business Planning Group, along the lines of that created by the MoD and BT, which meets regularly to identify and consider whether new or improved services are desirable. In the Galileo context, such a business planning group could comprise representatives from ESA, the EC, Member States and/or certain user groups. The terms of reference for such a planning group would need to be carefully delineated with respect to the regulatory functions of a separate Galileo regulatory agency. The MoD attributes a significant part of the success so far achieved in the implementation of the DFTS to the harmonious working relationship established between the DCSA and BT to ensure by means of which day-to-day issues can be resolved rapidly and efficiently. A potentially adversarial relationship between the Galileo regulator and the GOC may have trouble achieving comparable success.

4. The problem of specifying completely long-term contracts means that both principal (in this case, the EC, ESA and/or JU or their representatives in an agency created to administer and monitor the concession contract) and agent (the concessionaire) might have to rely on partnership, trust and reputation in regard to some elements of the concession. Reliance on these intangible elements makes it more difficult to monitor and legally enforce contracts. Consequently, the EC should minimise the number of intangible elements in the concession contract, but where these elements do exist, it should take steps to foster a harmonious working relationship built on trust with the concessionaire.

5. Judging by the IMSO Director’s reports to the IMSO Assembly and to IMO, IMSO and Inmarsat appear to have established a relationship which works successfully. Undoubtedly, this is helped by the regular meetings of the Public Services Committee as well as by the fact that the IMSO directorate is on-site, i.e., in Inmarsat’s headquarters building. The EC and ESA may wish to consider the utility of a similar practice with the GOC, i.e., not only regular meetings but an on-site presence. IMSO as the Special Shareholder receives the same reports as any other shareholder and

LN1:#20065849 163 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 164 is able to attend any shareholder meeting. While this is not exactly the case with the DCSA in the case of the DFTS and BT, it has an approximate parallel with the DCSA sharing or having access to BT’s DFTS information management system. These similarities between the DFTS and Inmarsat cases and the success attributed to the relationships as they have developed suggest that the EC and ESA take similar initiatives with the GOC.

11.1.11 BENCHMARKING & MONITORING PERFORMANCE

1. The EC/ESA will need to put in place some mechanism for monitoring the GOC’s and the Galileo infrastructure performance. The EC/ESA should also establish frequency with which performance will be monitored, (i.e., semi-annually, quarterly or more often), and decide who will do the monitoring. It probably would be useful to have more than one group or entity monitoring and benchmarking service performance. For example, the GOC should be expected to have a mechanism for monitoring its performance, and the EC/ESA may wish to have access to the output from that mechanism just as the MoD does in the case of BT in the DFTS case. ESA could also carry out its own independent monitoring of Galileo performance and the EC may wish to contract with independent consultants from the private sector to benchmark prices, if not also services.

2. Including benchmarking formulae in the Galileo concession contract would seem to make sense, except that it will be rather more difficult to compare Galileo prices against other suppliers in the industry since Galileo’s only serious competitor will be GPS, which does not offer value-added services as Galileo intends to do. Nevertheless, it may be possible to develop benchmarking formulae based on third- party GPS service providers.

3. The EC/JU should also take note of the NAO Report’s point about the need to benchmark prices before, as well as after, contract signature.

11.1.12 RISK ALLOCATION

1. One of the keys to getting good value for money from PPP is to identify all of the risks associated with a project and then allocate these risks to the party best able to manage them. Best value will be obtained by optimal risk allocation as distinct from maximum risk transfer. A detailed and systematic structure will also ensure transparency and clarity.

2. The risks to be apportioned in a project will change from deal to deal. There is no definitive template that can be applied; even on the same project, different bidding consortia will price for different risks and they will assume them to different degrees.

3. Whether the concession delivers value for money should depend not just on a purely financial balance of costs and benefits, but also on how risk is managed.

4. Although Skynet and Galileo are not directly comparable, both undoubtedly are considered to be critical infrastructure. That being the case, the GSB may wish to consider whether any sensitivities in the Galileo spacecraft construction merit a similar series of waypoint vetoes, as is provided for in the Skynet PFI.

5. In allocating risk, the EC/ESA/JU could begin with the same kind of questions as the MOD considers, such as:

LN1:#20065849 164 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 165 (a) financing (can the service provider (in this case, the concessionaire) be made responsible for establishing and maintaining the funding for service provision throughout the contract life?);

(b) design (can the service provider (the concessionaire) be made responsible for all components, facilities, resources and materiel required for design and development activity?);

(c) implementation (can the service provider (the concessionaire) be made responsible for all aspects of implementation, transition and certification?);

(d) operation (can the service provider (the concessionaire) be made responsible for delivery of a high quality service at required levels of availability and continuity?);

(e) usage (can the service provider (the concessionaire) be made responsible for costs associated with variations in demand?);

(f) regulatory change (can the service provider (the concessionaire) be made responsible for the consequences of changes in non-discriminatory legislation - such as national minimum wage?);

(g) obsolescence (can the service provider (the concessionaire) be made responsible for ensuring that the technology under-pinning service delivery - and the service delivery mechanism itself - remains consistent with contemporary market standards?);

(h) service provider lock-in (can the service provider (the concessionaire) be made responsible for ensuring that the service is provided in such a way as not to constrain MoD’s ability (in this case, the EC) to continue to meet its requirements cost-effectively in due course via an alternative supplier/solution?); and

(i) residual value/disposal (can the service provider (the concessionaire) be made responsible for the residual value of the assets at the conclusion of the service contract?).

6. The EC and ESA should recognise that the transfer of risks from the EC/ESA/JU to the concessionaire cannot protect the them from the risk that the concessionaire simply fails. It is essential that the Galileo public authority (together with the EC and ESA) actively manages this ultimately untransferable risk. As a minimum, the EC and ESA should have a strategy (a fallback/“Plan B”) that can be implemented should the concessionaire, for whatever reason, fail.

7. The EC/ESA/JU should ensure that, where responsibility for particular risks is to be transferred to the concessionaire, accountabilities are clearly established and procedures for escalating risks agreed. The EC/ESA/JU should have the capacity to monitor performance and to take early action in the event that the concessionaire runs into difficulty.

11.1.13 RISK MANAGEMENT

1. The EC/ESA/JU needs to ensure that bidders have included risk management as part of decision-making throughout their organisations as well as those of their prospective sub-contractors. Similarly, the EC and ESA should ensure that whoever is tasked with managing the concession on their behalf have taken similar steps. The

LN1:#20065849 165 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 166 EC/ESA/JU (or whoever is responsible for tendering the concession contract and evaluating bids) should, as mentioned above, ensure that the tender document includes provisions for requiring bidders to describe their risk management systems as well as provisions for monitoring their risk management systems after the contract is awarded.

2. The JU should take into account the Annexes to this report in devising a sensible risk management scheme which should apply to the Galileo concession. In particular, the GOC should be expected to put in place a risk management process which would comply with the practice recommended by the Turnbull Report.

3. Inmarsat’s risk mitigation strategies for manufacturers, joint funding of R&D and multiple sourcing all appear to have been effective and, therefore, could also be models for Galileo. Although much of the risk associated with Galileo may be expected to be carried by the GOC, not all risk can be transferred and, as mentioned above, the EC/ESA/JU and GSB should be satisfied with the GOC’s risk management and risk strategy as part of the concession contract.

4. The EC/ESA/JU should consider carefully the findings of the Turnbull Report. Consequently, the EC/ESA/JU should expect and ensure that the concessionaire directors will, at least annually, conduct a review of the effectiveness of the concessionaire’s system of internal control and then report to the EC/ESA/JU that they have done so. The concessionaire should also insist that such annual reviews take place by those with whom it has major subcontracts. The review(s) should cover all controls, including financial, operational and risk management.

5. A sound system of internal control depends on a thorough and regular evaluation of the nature and extent of the risks to which the company is exposed. The EC and ESA should ensure that, via the concession contract, they have an adequate level of insight into how the concessionaire evaluates risk.

6. The risk management review would include the following factors:

• the nature and extent of the risks facing the concessionaire;

• the extent and categories of risk which it regards as acceptable;

• the likelihood of the risks concerned materialising;

• the concessionaire’s ability to reduce the incidence and impact of risks that do materialise; and

• the costs of operating particular controls relative to the benefit thereby obtained in managing the related risks.

7. The EC/ESA should consider requiring the concessionaire to provide it with a risk management report on a regular basis which demonstrates that the concessionaire has considered:

• what it views as significant risks and assessed how they have been identified, evaluated and managed;

• the effectiveness of the related system of internal control in managing the significant risks, having regard, in particular, to any significant failings or weaknesses in internal control that have been reported;

LN1:#20065849 166 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 167 • whether necessary actions are being taken promptly to remedy any significant failings or weaknesses; and

• whether the findings indicate a need for more extensive monitoring of the system of internal control.

8. The concessionaire should, as a minimum, disclose that there is an ongoing process for identifying, evaluating and managing the significant risks which it faces, that it has been in place for the reporting period under review, that it is regularly reviewed by the concessionaire’s board and accords with, for example, the Turnbull Report guidance. Set forth below are some questions from the Turnbull Report. The EC/ESA should consider asking these questions when it reviews the concessionaire’s risk management reports:

• Are the significant internal and external operational, financial and other risks identified and assessed on an ongoing basis? (Significant risks may, for example, include those related to market, credit, liquidity, technological, legal, health, safety and environmental, reputation, and business probity issues.)

• Does the board have clear strategies for dealing with the significant risks that have been identified? Is there a policy on how to manage these risks?

• Are authority, responsibility and accountability defined clearly such that decisions are made and actions taken by the appropriate people?

• Are there established channels of communication for individuals to report suspected breaches of law or regulations or other improprieties?

• Is there appropriate communication to the board (or board committees) on the effectiveness of the ongoing monitoring processes on risk and control matters?

9. The EC/ESA should consider ensuring, as part of its required evidence that the concessionaire group has an appropriate risk management process in place, that the concessionaire identifies all possible risks and that such identification involves a rigorous assessment of trends, possibilities, dangers, their likelihood and impact (horizon scanning). Often this needs to involve people without a direct stake in the specific area of work itself to ensure objectivity. The EC/ESA should therefore ensure, via the concession contract, that the concessionaire has or will put in place people in its risk management process who can provide this objectivity, for example, if the concessionaire’s board has a risk management committee, the committee should include some independent directors.

10. The EC/ESA should consider ensuring that the concessionaire’s risk management process includes a process for making judgements about what level of risk is acceptable, that there is an explicit appraisal of risks, as well as benefits and costs, in all main decision processes, that the concessionaire’s risk management plans are underpinned by an assessment of its resilience to risks, that it plans ways to avoid, mitigate, anticipate and otherwise cope with the potential risks and uncertainties.

11. The EC/ESA/JU may wish to implement or ensure that the concessionaire has put in place something like the MoD’s “Gateway Reviews” in order to provide a thorough review, and sign-off, before work (in this case, building the satellite system) is allowed to proceed to the next stage of development. The MoD’s Gateway Review process is underpinned by an explicit assessment of the risks and opportunities of proceeding, informed where necessary by the views of all relevant stakeholders.

LN1:#20065849 167 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 168 12. The EC/ESA/JU should consider requiring the concessionaire to identify the roles and responsibilities of those handling risk and to identify the aims and principles used to guide actions in handling risk. Needless to say, responsibility for handling risks should lie with those who can best manage them.

13. The EC/ESA/JU should expect assurances from the concessionaire and be satisfied that the concessionaire’s decision-makers, if not all staff, have the skills to identify and assess risks and to take the action necessary to manage them. The EC/ESA/JU should be satisfied that the concessionaire has similarly satisfied itself with regard to its sub-contractors.

14. The EC/ESA/JU should consider requiring that the concessionaire has non-executive directors who play an important role in helping to identify strategic risk and to provide an independent perspective on the level of risk faced and the adequacy of measures to address risk.

15. The EC/ESA/JU should assess the strengths and weaknesses of the risk management systems of those bidding for the concession. By the same token, the prospective concessionaire might wish to do the same, especially with regard to how EC decisions might subsequently affect the concessionaire and to what mechanisms will be put in place to regulate and instruct the concessionaire.

16. Such assessment should include an assessment of the “risk management culture” within the bidders’ organisations.

11.1.14 OPERATIONAL RISKS

Galileo may consider following Inmarsat’s example of using a combination of insurance, on- ground and in-orbit spares to mitigate operational risks.

11.1.15 CONTRACT CHANGES

1. How effectively the concession contract deals with changes is an important element in ensuring value for money. The EC and ESA should consider mechanisms within the concession contract to reduce the opportunity for the concessionaire to claw back value, i.e., to raise its profitability levels. Nevertheless, to ensure the financeability of Galileo, a fair and well balanced structure to address the changes which will inevitably occur during a 15 to 20 year concession needs to be incorporated into the concession contracts. Lenders in particular will be very sensitive to any structure which could over time materially erode debt coverage ratios, which would likely occur if the concessionaire is not adequately protected against contract changes or other variations in the status quo such as changes in law and regulatory requirements.

2. The effectiveness with which changes are dealt with will be an important element in judging whether the contract period is appropriate. Under a long term contract such as that envisaged for Galileo it is important that:

• there is sufficient flexibility to handle change;

• there are mechanisms to ensure prices are competitive with the market; and

• the terms allow a new competition for the contract to be held at the end of the period.

LN1:#20065849 168 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 169 3. There is a risk that, over the life of the contract, the GOC may seek to change the pricing of services or the way it delivers services in ways which will improve its returns from the concession. This could impact adversely on the achievement of value for money to the extent that the EC or member States procure services from the GOC (e.g., the PRS). The EU and ESA should consider incorporating conditions under which the GOC’s prices might, in part, take account of other suppliers' prices and, if necessary, the concession could contain provision by means of which there can be value for money challenges (although this would need to be handled carefully to ensure bankability of the concession contract).

11.1.16 FINANCIAL TRANSPARENCY AND RISK MANAGEMENT

1. The EC should decide what level of financial transparency is to be expected from the GOC. Financial transparency is particularly important where there are limited market comparators for a service and hence benchmarking is problematic. In such circumstances, it is vital for the public authority (or Galileo regulator) to have confidence that the concessionaire’s cost structure and profit level are reasonable in the context of the risk which are being assumed.

2. The level of financial transparency should be determined taking into account the need to demonstrate value for money. The EC/JU should determine the factors that need to be taken into account in order to demonstrate VFM.

3. Like Inmarsat, Galileo will be a global system with services providers, users and revenues from many different countries in addition to those in the EU. Hence, the GOC may be expected to use similar instruments to those of Inmarsat to hedge its exposure to interest rate and foreign currency risk.

4. The EC/ESA should have contractual rights to share in refinancing gains if the concessionaire decides to refinance the deal. This has become customary practice in the UK PFI market. However, the public sector’s share of refinancing gains should depend upon the degree of revenue risk assumed by the concessionaire (i.e.: the higher the public sector support, the more refinancing benefit it should expect). See Annex 2.

11.1.17 VALUE FOR MONEY CHALLENGES

1. Drafting a concession contract which lays down all circumstances under which a VFM challenge could be made may not be beneficial, since it will be difficult (if not impossible) to identify in advance all such circumstances. While some number of circumstances could be identified in the concession, some might argue that consideration should be given to a clause which provides for undefined exceptional circumstances. The problem is that the bidders may price in premiums accordingly (and such clauses could significantly impair the attractiveness of the transaction to banks and other financial stakeholders).

2. Incorporating sensible value for money challenge provisions in the Galileo concession may well make sense, but the determination to include such provisions will need to be made with a view to the powers of the Galileo Regulatory Agency. If the Galileo regulator will be vested with powers for capping service charges similar to those of Oftel, for example, the VFM challenges may be unnecessary.

3. If a provision for VFM challenge were included in the Galileo concession contract, and given the fact that Galileo will offer a more bounded range of services than the DFTS, it should be easier to establish a formalised mechanism for determining VFM

LN1:#20065849 169 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 170 and hence the criteria for a challenge (although the issue would need to be handled carefully so as to permit the project to be financed).

4. To ensure that value for money is maintained over the lifetime of a project, it is essential that PFI/PPP contracts have appropriate mechanisms in place, such as benchmarking, market testing, and open book accounting. The EC and ESA should consider the need to incorporate similar provisions into the concession contract.

5. To achieve value for money over the life of the concession, the EC and ESA will need a strong contractual framework allied with good relationship skills in order to foster a spirit of partnership with their private sector partners.

6. The pre-contract appraisal of the concession should indicate how the concession will be evaluated after completion and how the results of the evaluation will be disseminated.

7. There is a risk that if a contractor builds high rates of return into the contract, it will be more expensive than if undertaken in the public sector. PFI contracts often contain specific procedures for the parties to vary the deal. The EC/ESA/JU will need to watch that change procedures are not abused as a covert means for increasing the profit margins of the concessionaire.

8. The EC/ESA/JU should not insulate the concessionaire from the consequences of the risks it has been paid to take on.

9. The concept of price cap regulation may be worth considering for its suitability within a European wide system. However, this would need to be analysed carefully in the context of Galileo where the concessionaire may be expected to rely less on public sector payments (as for NATS UK) and more on generating funds from private corporations and other consumers.

11.1.18 THE OFFICIAL FACE

The EC/ESA will need to devise an arrangement like that which Paradigm/Astrium and Inmarsat have with the DTI/RA with regard to the ITU and third countries, where Galileo will need an “official face”. Especially in the context of WTO rules, Galileo will need to be based in and under the jurisdiction of a single country, which will act as its administration. The EC will need to have some discussions in collaboration with the (prospective) GOC and the host country in order to ensure that there is a shared understanding, an agreed procedure and philosophy with regard to third country and international regulatory dealings at State level.

11.1.19 SERVICE GUARANTEES

MoD’s service assurances are not exactly the same as the service guarantees envisaged in the Galileo context, although there are some parallels. MoD’s service assurances are designed to ensure that MoD gets what it wants, whereas the Galileo service guarantees will between the GOC (and its SPs) and users of Galileo’s commercial services. Nevertheless, MoD’s sample list of service assurances contains items which the EC/ESA may wish to build into its concession contract for Galileo. See section 5.3.3.

11.1.20 A PUBLIC SERVICE AGREEMENT

1. The EC and/or JU may wish to consider the use of a Special Share in the Galileo Operating Company, to be held by a Galileo Public Authority (GPA), as one mechanism to ensure certain specified rights (like those of the Inmarsat Special

LN1:#20065849 170 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 171 Shareholder) and to be able to track “from the inside” what the GOC is doing. However, such a share would be unusual in the context of a PPP project and not required if the EC/JU is satisfied with the level of regulatory oversight which will ultimately be put in place.

2. The IMSO-Inmarsat Public Services Committee could be a model for the EC/ESA/JU to implement with the Galileo Operating Company. MoD has a similar arrangement with BT in regard to the DFTS, and attributes a good measure of the success so far achieved to this mechanism. Like the PSC, the EC and the GOC could, inter alia, discuss and resolve any issues relating to the GOC’s implementation of its public service obligations. Again, this will need to be considered within the regulatory framework which is not the subject of this report.

11.1.21 LEGISLATION/INSTITUTIONAL STRUCTURES

As seen from the case studies, many PPP schemes have originated from a need determined by governing public bodies. From that moment, legislation and public bodies were set up to implement the projects. This is not something that has yet been achieved for Galileo. The Toll Collect and the Messina Straits Bridge projects have both needed changes in legislation in order to make them attractive for private sector investment. In Toll Collect’s case, the scheme is structured so that the payment mechanism is guaranteed. By collecting duties that had to be paid by HGV users, Toll Collect is assured that all users will pay their tolls, thereby virtually guaranteeing revenue. Although there is not a clear cut case for this to happen with Galileo, it is worth bearing in mind that the key requirement for Galileo is that of public benefit. The concessionaire is simply a vehicle to help Galileo become a reality, and therefore give the public benefits that it can deliver. The principal aim is not to bring substantial business to infrastructure providers but instead to achieve potentially significant public benefits and legislation should be structured to support this objective.

11.1.22 THIRD PARTY LIABILITY

Galilei has already undertaken studies of liability. Nevertheless, the EC/ESA/JU may wish to consider Inmarsat’s methods for dealing with liability, through a combination of insurance policies, operational practice and sharing with service providers, as a model for Galileo.

11.1.23 MANAGING THE CONCESSION

1. Just as staff responsible for managing PFI projects must be equipped with the appropriate skills as distinct from the skills needed to negotiate deals at the outset, the EC and ESA should ensure that their staff who manage the concession contract have the relevant skill set and that there is a process for keeping that skill set up to date.

2. The UK government has determined that decision-makers need to communicate (in the two-way sense of the word) with those potentially affected by risks and with those who can help manage the risks. Decision-makers need to make judgements in as open a way as possible about the nature of risk and how responsibilities are or should be allocated. The EC/ESA should consider how open they wish to be with regard to the risks associated with the Galileo project. Certainly, they should expect transparency and reasonably full disclosure on the part of the concessionaire to the entity which is managing the concession on behalf of the EC and ESA.

3. Consideration should be given to the role of consumers in decision-making. For example, NATS UK depends on the regulator to ensure consumer participation in setting performance indicators and other safety levels, while NAV Canada has

LN1:#20065849 171 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 172 involved the consumers at Board member level so that they are involved in determining general policies. Note, however, that involving consumers at board level, in price setting and determining safety and performance levels may be more difficult to implement for Galileo as its consumers will be diverse and of varying degrees of sophistication. The NAV Canada structure is arguably more suited to a not-for profit organisation. This is not the case with Galileo, where both equity and debt stakeholders are being asked to take relatively significant commercial risk and in such circumstances, it is arguable that the management of Galileo should be left as far as is appropriate to the board members of the GOC.

4. The public sector should not be involved in day-today management. As the NATS UK and NAV Canada case studies show, the confidence of the financial sector is enhanced where it is clear that management decision making is based on macro- economic discipline and shareholder control.

5. Separation of shareholder and day-to-day management should be strictly ensured. In NATS UK, while the board of the holding company (NHL) is not different from the managing company (NATS), the separation of company management from shareholding issues enhances the efficiency of the company’s operations.

11.1.24 ACCOUNTABILITY

1. The concession contract should establish clear accountability. The EC/JU will need to decide to what extent the concessionaire/prime contractor (or SPC) should be liable to make compensation payments if its sub-contractors fail to perform.

2. It will also need to decide who should have liability with regard to the performance of sub-contractors, especially if the GSB, EC/JU or a Galileo regulator were to direct the GOC to provide service in some unusual way.

11.1.25 TERM OUT PROVISIONS AND RECOMPETITION FOR CONCESSION

1. The EC/JU should consider carefully the appropriate duration of the concession in light of the costs and benefits associated with concession terms of 10,15 or 20 years. A duration of 20 years seems to be favoured at the moment, but this length of term puts at greater risk the prospect of renewed, genuine competition at the end of the term. The EC and ESA should ensure that the concession contract includes provisions for renewed competition at the end of the term and that any transfer payments which a new concessionaire makes to the existing concessionaire are not so high as to undermine the prospect of renewed competition. Of course, the public sector considerations need to be balanced against the needs of the private sector stakeholders in the GOC. Hence, the concession needs to be sufficiently long to permit a viable return on equity – a longer term will permit the GOC to borrow from financial institutions for longer tenors, thus enhancing its return on equity and reducing its dependence on public sector availability and output payments.

2. The DFTS transfer payment arrangements merit close study by the EC and/or JU since it may wish to develop comparable arrangements for the transfer of Galileo assets at the end of the concession contract to another supplier.

3. Like MoD, the EC/JU will need to construct very carefully the transfer payment arrangements in the Galileo concession contract, with particular attention to ensuring that the first concessionaire is not overpaid for assets, the costs of which it has already recovered during the term of the concession. Also, the transfer payments should not be so high that they act as a disincentive to other prospective bidders for the next concession period and raise the cost of services to Galileo users

LN1:#20065849 172 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 173 4. Long contract periods for telecommunications and information technology contracts carry risks because these markets are subject to rapid technological changes and purchasers may want new forms of service delivery. A long term contract with one supplier therefore presents the risk that services could become obsolete. It can also limit scope for achieving value for money for new requirements if it means their provision will not be subjected to a competition. The EC and ESA should consider the need for the concession contract to contain provisions for technology refreshment.

5. The EC/ESA/JU should consider what information they expect the concessionaire to make available at or near the end of its term. This information requirement should form part of the initial concession contract. They should build into the contract all the measures necessary to ensure that an effective recompetition is possible. In doing so, the contract should include a recognition that the procedural aspects of the recompetition will be subject to the organisational and political framework in which the EC operates at the time and, as a consequence, it is not possible to specify that framework at initial contract let.

6. The risk to future competition is no less important to Galileo than to the DFTS. The EC/JU should negotiate a contract with the GOC which contains provisions which will ensure genuine competition for a new concession period. There is an obligation on BT to provide certain information towards the end of the DFTS contract term. The EC /JU should insert similar provisions into the Galileo concession contract.

11.1.26 REMEDIES

1. The EC/JU will need to build in remedies in the event of a failure by the GOC to comply with the terms of its concession contract. Like those in the DFTS contract, the remedies will need to vary in proportion to the seriousness of the failure to comply.

2. Service credits act as an incentive for the service provider to return a service to full performance as quickly as possible in the event of a failure. There are trade-offs to consider. The EC/JU will need to decide whether a service credit regime might be appropriate in the Galileo case and, if so, what level of service credit – ranging up to 100 per cent – might be appropriate and what level of service failure should be allowed before service credits are incurred. If the service provider fails beyond the maximum of credits payable to the public authority, extreme action could be taken and parts of the contract could be taken away from it. Although Galileo will mostly be used to provide service to the public rather than the public authority, the authority should nevertheless monitor the performance of the GOC and, in particular, service delivery. If the delivery of any service fails to meet the standards set under the concession contract, there should be contractual provisions which invoke remedies, including service credits.

3. Brand image and reputation may be just as important an incentive as service credit, which is not to say that one should do away with a service credit regime, only that loss of reputation will act as another deterrent to poor performance.

4. The concession contract should contain an escalation process which provides for increasingly higher levels of management to become involved as necessary in order to resolve disputes.

5. The EC may wish to build into the Galileo concession contract an escalating set of remedies similar (but not limited) to those available to IMSO and MoD. Consideration will also need to be given to the dispute resolution forum which will apply, should the parties be unable to settle disputes amicably. Many corporations and public

LN1:#20065849 173 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 174 authorities now prefer disputes to be referred to binding arbitration rather than for such disputes to be litigated publicly in the courts.

6. The EC/ESA/JU should ensure that remedies built into the Galileo concession are clearly worded so as to be enforceable. This should not mean that certain provisions that express best endeavours should be omitted, only that the EC/ESA/JU as well as the concessionaire are clear about which provisions are enforceable and which are not. See, for example, section 6.3.8 for the discussion of Clause 7 regarding remedies in the Inmarsat Public Services Agreement.

11.1.27 INDEPENDENT MONITORING

1. The UK Public Accounts Committee observed that, having entered into PFI contracts, authorities were not likely to admit that they had got it wrong. That being the case, there is a need for independent monitoring of contracts. The EC and ESA have already expended significant political capital in pushing Galileo forward, so this may be an uncomfortable recommendation. Nevertheless, the EC and ESA, if not the Council, may wish to consider the utility of establishing some separate entity for monitoring the progress of the concession. Such a function could be performed by the Galileo regulator.

2. The regulatory mechanism adopted under the UK PPP, i.e. a separate economic, safety and civil-military interface regulation, albeit through a single point of contact in the CAA, makes for a transparent and reliable oversight programme.

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11.2 PROCUREMENT

11.2.1 APPLICABLE PROCUREMENT RULES

The analysis in Section 10 has considered the legal rules applicable to Galileo, but the actual application of those rules will depend on the legal structure ultimately chosen and the commercial decisions taken in structuring the overall procurement strategy for the selection of the Galileo Concessionaire.

In establishing the optimum procurement strategy for Galileo, it is first necessary to establish precisely the key objectives for Galileo, being:

• independence (from GPS);

• consistent performance (including high latitudes) over Europe;

• social and macro-economic benefits (cost benefit analysis based justification for public funds);

• preference for "the market pays rather than the tax-payer pays" philosophy; and

• substantial private investment.

In seeking to achieve the above objectives, the public sector is not so much seeking to procure an infrastructure, but rather is seeking to procure a service or output. Private sector financial participation is enhanced by providing the private sector with the opportunity to deliver services, only a sub-set of which are paid for by the public sector. It therefore makes sense for the procurement philosophy of the JU/Galileo public authority to be output based, or service based rather than infrastructure-based.

As can be seen from Section 10, the procurement rules are complex, but essentially there are three different approaches reflected in the “Open”, “Restricted” or “Negotiated” procedures.

Due to the complexity of the Galileo project, it is clear that the adoption of an open or restricted process would not be appropriate. In particular, the nature of the services to be provided by the Galileo Concessionaire cannot be framed with any great precision at the outset of the procurement process. In order for the JU to assure itself that the concession is awarded to the best “all round” bidder, it will be necessary for the bidders to be assessed on a number of commercial, technical and other criteria. Inevitably, it will be necessary to clarify the terms of the offers that are received by the JU and to refine the details which will ultimately form the contractual framework agreed with the winning bidder. Bearing these parameters in mind, one is led to conclude that a negotiated procedure is essential to enable the public sector to achieve the desired social and macro-economic goals and in particular to ensure value for money and a favourable comparator with the public sector alternatives to the PPP bidding process.

We have reviewed the PWC Phase II Report and are broadly in concurrence with the approach to procurement which has been proposed. However, while we concur that a negotiated procedure would be the most appropriate procurement route, until further particulars become available regarding the precise scope of the procurement being undertaken by the JU/Galileo public authority, it will not be possible to give a final view on the application of the Procurement Directives.

LN1:#20065849 175 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 176 Having said this, if, as PWC recommends, the JU negotiates the turnkey contracts relating to the deployment of the satellite constellation, the procurement analysis will likely focus on the service/output requirements of the concession. This means that of all the Procurement Directives, the most likely to be applicable will be the Services Directive.

Clearly, assuming a service/output based procurement, as outlined in Section 10.2.5 above, the “nature of the services to be provided is such that specifications cannot be drawn up with sufficient precision to permit the use of the open or restricted procedure”, and therefore we are of the view that this exception permitted under the Services Directive would be applicable to the procurement of Galileo. This would permit the use of a negotiated procedure.

11.2.2 THE TENDERING PROCESS

Assuming that the negotiated procedure is to be used, this would need to be combined with a call for competition. It is relatively customary in PPP bid projects for the tendering process to be a two-step process, commencing with a pre-qualification and down selection phase, followed by a competitive bidding phase. Bearing in mind the highly specialised services to be provided by the Galileo Concessionaire and the relatively limited pool of private sector entities which have the necessary technical and industrial capability to carry out the services, we would endorse an approach which would keep a wide spectrum of interested parties involved in the process. We have considered the “Expression of Interest” (EOI) process which is being adopted by the JU and consider this to comply with the EU procurement rules. A narrowing down of the field of potential bidders can take place during the proposed initial bid phase (during which bidding groups are likely to form prior to presentation of at least two credible bids for the concession). During the procurement process, it is likely that the definition of the public sector service requirements will evolve. It is also likely that the constraints that must be placed on the private sector will change. In the interests of ensuring that an appropriate competition is held during both the initial bid period and the final selection of the Galileo Concessionaire, careful definition of both the requirements and constraints is needed throughout the process. Over specification of either in the early phases of the process could lead to potential bidders unnecessarily excluding themselves or being unnecessarily excluded by the selection process and criteria. The potential negative consequences are reduced value for money for the public sector, or potential legal challenges to the procurement process. Conversely, any substantial under specification of service requirements or constraints in the early phases of the process could lead to an excess of pre-qualifying bidders or potential bidders withdrawing at a later stage.

11.2.3 GLOBAL PARTICIPATION

Bearing in mind the relatively small pool of credible bidders for the Galileo concession, it will be important if the public sector is to achieve its economic and strategic goals, for the tender process to facilitate bids from interested parties both within and outside the EU. We agree with PWC that in order for this to take place, the JU should make a clear policy statement that the involvement of non-EU bidders (or consortia partly made up of non-European entities) is both acceptable and encouraged.

It should be borne in mind that the EU and Member States have obligations under the WTO procurement rules and that non-EU companies which have establishments in the EU also have rights of non-discrimination. Therefore, we view such a policy statement by the JU as reflective of the laws and rules which are in any case applicable. However, if such a policy statement is not made, it is likely that a number of credible potential non-European participants will not wish to be involved in the process because of a perception that their interest will not be welcomed and that EU entities are more likely to be viewed favourably. Hence, an already relatively narrow field of potential stakeholders might be narrowed further,

LN1:#20065849 176 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 177 thus leading to a reduction in the competitive process and the introduction of good ideas and technological innovation.

11.2.4 THE BENEFITS OF PUBLIC SECTOR FINANCIAL SUPPORT DURING THE PREPARATION OF BIDS

In order to develop a binding offer for the long-term delivery of the Galileo services to the public sector, serious consideration should be given to a substantially publicly funded final bidding phase. From experience of previous large scale PPP development work, it is clear that the preparation of such a bid is likely to incur significant cost and require significant dedication of time by the bidders. This therefore represents a significant risk to the private sector in bidding, and a significant degree of financial support from the public sector is likely to be required in order to attract the minimum requirement of two credible bidders. The result of this investment from both the public and the private sectors should be to reduce the overall cost of Galileo service delivery to the public sector, producing savings significantly in excess of the cost of the competitive tendering process (since the short-listed bidders will be incentivised to commit significant resources to refining their bids and producing an innovative and more thorough proposal).

The process must ensure that a minimum of two competitive bids are received. To this end, we would recommend that the funding support for these bids should be structured in such a way as to ensure that appropriate, binding offers are submitted. This may be in the form of requiring bidders to provide financial guarantees that binding offers will be submitted, perhaps in the form of a bond, letter of credit, or bank guarantee. Alternatively, the payments made under the contract could be structured such that the private sector must contribute throughout the bidding phase and have a final high value milestone payment linked to the submission of a bid.

In order for such guarantees to be effective and fair, it is essential that the parameters of the bid be established at the outset. For example, minimum guaranteed service level and ceiling price for the delivery of the services for a minimum period.

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12 DEFINITIONS AND ACRONYMS

AOR-E Atlantic Ocean Region-East

AOR-W Atlantic Ocean Region-West

B-GAN Broadband Global Area Network

BMVBW German Federal Ministry for Transport, Building and Housing

BNSC British National Space Centre

BOT Build Operate Transfer

BOXER An MoD bespoke secure telecommunications system

BT British Telecommunications, plc

CESG Communications Electronic Security Group

CPA Classification of Products According to Activities

CPS Cardinal Points Specification

DCSA Defence Communications Services Agency

DFTS Defence Fixed Telecommunications System

DLO Defence Logistics Organisation

DPA Defence Procurement Agency

DPA Defence Procurement Agency

DTI Department of Trade and Industry

EADS European Aeronautic Defence and Space

EC European Commission

EC Treaty EC Treaty of Rome 1957

ECJ European Court of Justice

EPIRB Emergency Position Indicating Radio Beacon

ERC European Radiocommunications Committee

ESA European Space Agency

EU European Union

Eutelsat European Telecommunications Satellite Organisation

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FCC Federal Communications Commission (US)

FSA Financial Service Authority

FSMA Financial Services and Markets Act 2000

FstrPrivFing A German Federal law allowing Private Investment in Public Infrastructure

GATS General Agreement for Trade in Services

GCHQ Government Communications Headquarters

GMDSS Global Maritime Distress and Safety System

GNSS Global Navigation Satellite System

GOC Galileo Operating Company

GPA Government Procurement Agreement of the World Trade Organisation

GPS Global Positioning System

GSB Galileo Security Board

GSM Global System for Mobile Telecommunications

HGV Heavy Goods Vehicles

ICAO International Civil Aviation Organisation

ICO spin-off from Inmarsat

IGO Intergovernmental organisation (see also ISO)

IGS Internet Gateway Service

IMO International Maritime Organisation

IMSO International Mobile Satellite Organisation

IOR Indian Ocean Region

IPO initial public offering

IPR Intellectual Property Rights

IPT Integrated Project Team

ISO Intergovernmental Satellite Organisation (see also IGO)

IT Information Technology

ITN Invitation to Negotiate

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ITSEC Information Technology Security Evaluation and Certification

ITSO International Telecommunications Satellite Organisation

ITT Invitation To Tender

ITU International Telecommunication Union

IWG Intersessional Working Group

JU Joint Undertaking

kbit/s kilobits per second

LCIA London Court of International Arbitration

LDCs least developed countries

LES land earth station

LESO Land Earth Station Operator

Member States Members of the European Union

MES mobile earth station

milsatcom military satellite communication

MoD Ministry of Defence

MRCC Maritime Rescue Co-ordination Centre

MSC Maritime Safety Committee

MSI Maritime Safety Information

MSS Mobile Satellite Service

MTA Master Transition Agreement

NAO National Audit Office

NCSs Network Control Stations

OBU On Board Unit

Ofcom Office of Communications

Oftel Office of Telecommunications

OJ Official Journal of the European Communities

ORBIT Act Open-market Reorganization for the Betterment of International Telecommunications Act (US)

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PAC Public Accounts Committee

PDS Project Definition Study

PFG Private Finance Group PFG

PFI Private Finance Initiative

PIN Prior Information Notice

plc Public Limited Company

POR Pacific Ocean Region

PPI Private Participation in Infrastructure

PPP Public Private Partnership

Procurement Council Directive 93/97/EEC (as amended) concerning the Directives coordination of procedures for the award of public works contracts (Works Directive)

Council Directive 93/36/EEC (as amended) coordinating procedures for the award of public supply contracts (Supplies Directive)

Council Directive 92/50/EEC (as amended) relating to the coordination of procedures for the award of public service contracts (Services Directive)

Council Directive 93/38/EEC (as amended) coordinating the procurement procedures of entities operating in the water, energy, transport and telecommunications sectors (Utilities Directive)

PRS Public Regulated Service

PSA Public Services Agreement

PSComparator Public Sector Comparator

PSC Public Services Committee

PSSP Public Sector Service Payment

Public Directives Council Directive 93/97/EEC (as amended) concerning the coordination of procedures for the award of public works contracts (Works Directive)

Council Directive 93/36/EEC (as amended) coordinating procedures for the award of public supply contracts (Supplies Directive)

Council Directive 92/50/EEC (as amended) relating to the coordination of procedures for the award of public service

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PWC PriceWaterhouseCoopers

PWC Report Inception Study to Support the Development of a Business Plan for the Galileo Programme by PriceWaterhouseCoopers dated 14 November 2001

R&D Research and Development

RA Radiocommunications Agency

Regulations Domestic regulations implementing Procurement Directives

Remedies Directives Council Directive 89/665/EEC (as amended) on the co- ordination of the laws, regulations and administrative provisions relating to the application of review procedures to the award of public supply and public works contracts

Council Directive 92/13/EEC (as amended) co-ordinating the laws, regulations and administrative provisions relating to the application of community rules on the procurement procedures of entities operating in the water, energy, transport and telecommunications sectors

ROA Recognised Operating Agency

RR Radio Regulation (ITU)

SARPs Standards and Recommended Practices

SCC Satellite Control Centre

SCSAP Satellite Communication System Analysis Package

SDR Strategic Defence Review

SOLAS Safety of Life at Sea Convention

SP Service Provider

SPC Special Purpose Company

S-PCS Satellite Personal Communications Service

SPI Smart Procurement Initiative

TSF Télécoms Sans Frontières

UFP Italian Treasury Project Finance Taskforce

UKLA UK Listing Authority

UMTS Universal Mobile Telecommunications Service

UNCITRAL United Nations Commission on International Trade Law

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UNCOPUOS United Nations Committee on the Peaceful Uses of Outer Space

UNITER An MoD bespoke secure system.

Utilities Directive Council Directive 93/38/EEC (as amended) coordinating the procurement procedures of entities operating in the water, energy, transport and telecommunications sectors

VFM value for money

VSAT very small aperture terminal

WTO World Trade Organisation

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ANNEX 1

PFI Feasibility Checklist

The following are extracts from the MoD’s PFI feasibility checklist399, which aims to provide a list of the key issues to be addressed in determining whether any given Defence Procurement Agency project - or any element of it - may be best pursued under the Private Finance Initiative.

No checklist can be definitive. The objective is to provide a list of issues that is broadly comprehensive but not overly prescriptive. The checklist should be used as a catalyst for thinking about the key feasibility issues of a given project; it is not a substitute for that thinking.

The checklist is focused on the issues relevant at early (i.e. concept and early assessment) stages of the project though many of the issues will remain relevant and will need to be managed throughout the procurement process.

The criteria in the paper are phrased in such a way (as questions) that a “yes” answer suggests positive potential for PFI and a “no” answer suggests a negative potential. Not all questions will be answerable at an early stage. The identification of “don't knows” does however have the additional benefit of helping the project team produce project plans to address the appropriate criteria in an effective and timely fashion.

The criteria within each section are divided into two groups:

1. Core criteria: those that will have the greatest impact in determining PFI feasibility.

2. Supplementary criteria: additional criteria that, except in the most clear-cut cases - will need to be considered in the selection of the preferred procurement option.

The way these criteria contribute to a feasibility decision may be complex. In interpreting the result of a feasibility review making use of the checklist, the following should therefore be borne in mind:

• Not all criteria are of equal weight and it is therefore not valid to count up the “yes’s” and “no’s” to obtain an answer.

• Certain groups of criteria will have a cumulative effect greater than the individual sum of their parts.

• A negative and positive response to a given criterion do not necessarily carry the same weight (i.e. a "yes" could be significant whilst a "no" may not and vice versa).

In many cases, the resulting argument will not be clear cut.

Is PFI appropriate?

The following criteria review whether PFI is an appropriate procurement option to deliver the project requirement.

Core Criteria

399 See www.ams.mod.uk/ams/content/docs/toolkit/ams/links/pfg_web/library/dpapfu/gnotes/feas.htm

LN1:#20065849 184 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 185 A.1 Is the requirement deliverable both as a service and as a long term arrangement? (see also criteria A.5 and A.6 below)

A.2 Does the project require significant levels of investment in new capital assets?

A.3 Does the scope of the service lend itself to providing the service provider with "end- to-end" control of the relevant functional processes.

Supplementary Criteria

A.5 Can the requirement be expressed clearly in output-based terms?

A.6 Is it possible to conceive meaningful, high level key performance indicators that could be used as the basis for measuring and remunerating the successful delivery of the service?

A.7 Is service certification likely to be straightforward in terms of agreeing measurable criteria and satisfying the interests of all MoD-side stakeholders?

A.8 Does the service have clear boundaries (especially with respect to non-negotiable areas of MoD-side control)?

A.10 If there are interfaces with other projects, are they clear and manageable?

A.11 Is the PFI service provider likely to have complete ownership of the IPR associated with the performance/design/development of the assets for the new service?

A.12 Will all existing or planned contracts within the scope of the project - or interfacing to it directly - be complete before the start of the new service?

Is PFI workable?

The following criteria review whether the project has the potential to deliver a workable deal under PFI.

Core Criteria

B.1 Does the service lend itself to establishing a genuinely incentivised payment regime to ensure that best value is achieved and retained in terms of price, service level quality and delivery mechanism?

B.2 Is there likely to be sufficient market interest to generate and sustain healthy competition throughout the procurement? (objectively is the proposed risk allocation fair and reasonable? – see also criteria C.3).

B.3 Is the procurement feasible within the required timescale? Is there sufficient time for: resolution of key MoD-side issues; production/approval of procurement documentation; staged down-selection and evaluation of bidders, negotiation, approvals and due diligence?

Supplementary Criteria

B.5 Does a significant market with sufficient capacity for these services exist in the private sector?

LN1:#20065849 185 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 186 B.6 Does the nature of the deal and/or the strategic importance of the work and/or the prospect for further business suggest that it will be seen by the market as a potentially profitable venture?

B.7 If there already has been any exposure to the market, has MoD’s commitment to a PFI solution for this project been demonstrated?

B.8 Is the technical solution deliverable given the risk associated with design, development and implementation?

B.9 Does MoD have the skills and resources to define, deliver and support the service throughout the procurement and the subsequent delivery period?

Is PFI economic?

The following criteria review whether the project has the potential to deliver good value for money under PFI .

Core Criteria

C.1 Is there scope for innovation in either the design of the solution or in the provision of the services? [Does some degree of flexibility remain in the nature of the technical solution/service and/or the scope of the project? Is the design free from the constraints of imposed technical standards?]

C.2 Is there a real prospect that the service could be delivered at lower cost (e.g. through cheaper manpower, more efficient working practices)?

C.3 Is the private sector likely to be able to manage the generic risks associated with the project more cost-effectively than MoD?

C.4 Given the possibility of changes to the requirement and/or the operating environment, should it be possible to sustain value for money over the life of the project utilising, as appropriate, mechanisms such as benchmarking and technology re-fresh?

C.5 Could the private sector improve the level of utilisation of the assets underpinning the service (e.g. through selling, licensing, commercially developing for third party usage)?

Supplementary Criteria

C.6 Is the private sector able to exploit economies of scale through the provision, operation or maintenance of other similar services to other customers (not necessarily utilising the same assets)?

C.7 Does the private sector have greater experience/expertise than MoD in the delivery of this service? Is the service non-core to MOD?

C.8 Is a PFI procurement likely to deliver improved value for money to MoD as a whole?

Risk Allocation

In the context of "appropriateness" criteria A.8 – A.12, and the allocation of responsibilities between the service provider and other parties that those criteria imply, does the project suggest the potential for significant levels of risk allocation to the private sector in terms of:

(a) design, (can the service provider be made responsible for all components, facilities, resources and materiel required for design and development activity?)

LN1:#20065849 186 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 187 (b) financing, (can the service provider be made responsible for establishing and maintaining the funding for service provision throughout the contract life?)

(c) implementation, (can the service provider be made responsible for all aspects of implementation, transition and certification?)

(d) operation, (can the service provider be made responsible for delivery of a high quality service at required levels of availability and continuity?)

(e) usage, (can the service provider be made responsible for costs associated with variations in demand?)

(f) regulatory change, (can the service provider be made responsible for the consequences of changes in non-discriminatory legislation - such as national minimum wage?)

(g) obsolescence, (can the service provider be made responsible for ensuring that the technology under-pinning service delivery - and the service delivery mechanism itself - remains consistent with contemporary market standards?)

(h) service provider lock-in, (can the service provider be made responsible for ensuring that the service is provided in such a way as not to constrain MoD’s ability to continue to meet its requirements cost-effectively in due course via an alternative supplier/solution?)

(i) residual value/disposal, (can the service provider be made responsible for the residual value of the assets at the conclusion of the service contract?)

Overall, is the project likely to be free from large and/or uncertain MoD-side risks? (i.e. are there significant uncertainties in the whole life cost of service provision that the service provider is unlikely to want to take responsibility for without imposing an unacceptably high premium?)

Aside from the risk allocation, does the private sector have inherently lower risk working practices/solutions or more effective risk controls? Are they able to manage and control long term issues, such as obsolescence, effectively?

LN1:#20065849 187 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 188

ANNEX 2

Managing PFI Projects

Among the advantages of PPPs and PFIs attributed to the public sector are these:

• risk can be reduced by transfer to the private sector;

• risk allocation, e.g. cost over-runs, can be managed more effectively through incentive- based contracts;

• greater transparency when political meddling in project specification occurs;

• encouragement of innovation in project design, construction and operation and maintenance;400

• the public sector can obtain better value for money from existing budgets;

• it results in greater competition across a wider range of activities;

• it uses the advantages of private sector assets, skills and expertise in balancing cost, risk and returns;

• PFI enables improved quality of services through opportunities for innovation and the application of the latest commercial techniques;

• it provides additional capital investment beyond current budgetary allocations, so that worthwhile projects which could not otherwise be funded are allowed to proceed; and

• public sector staff are exposed to private sector management, commercial and financial skills.

Similarly, PFI and PPP offer benefits to private industry, among which are the following:

• it creates more opportunities for business with government;

• it creates opportunities to use spare capacity and to share overheads;

• it enables long-term investment against the security of income from a long-term contract ; and

• it provides further support for the industrial base.401

Recognition of these and other advantages has resulted in the fact that PFI is a major form of government procurement in the UK. PFI contracts currently in force have committed departments to future expenditure of around £100 billion. These contracts are often long term arrangements involving public expenditure over extended periods, up to 30 years or more. 402

400 p.5, Parker & Hartley. 401 pp. 12-3, Parker & Hartley. 402 Paras 1 & 2. Introduction. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts.

LN1:#20065849 188 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 189 In view of the magnitude of PFI deals already signed or in the making, effective management of these deals has become not surprisingly a key issue of concern to ensure that the taxpayer truly does get value for money. This concern has prompted wide-ranging surveys of PFI deals undertaken by the UK government by the National Audit Office and the Public Accounts Committee.

In June 2002, the PAC produced a report entitled Managing the Relationship to Secure a Successful Partnership in PFI Projects, which reviewed a report of the same name produced by the NAO. The NAO examined the evaluation of PFI projects in progress, how value for money can be maintained in the long term and the skills and guidance that are needed by the public sector to manage these contracts successfully.403 The NAO Report was based on a survey of 121 PFI projects where contracts had been let prior to 2000. The survey results included perceptions of authorities and contractors about how the contracts are working out.

On the basis of the NAO Report, the Public Accounts Committee took evidence from the Office of Government Commerce (OGC)404 and the Major Contractors Group. As the PAC Report makes some points which may be of interest to GALILEO, a summary of key points is included here.

Maintaining value for money

The PAC said it was very concerned that as many as 23 per cent of authorities surveyed considered that there had been a decline in value for money in PFI projects after contract letting. A variety of reasons for the decline were cited, including high charges for additional services, user dissatisfaction and expected benefits not being realised.405 A recurring feature in traditional construction projects is that departments accept lowest price tenders, but contractors then seek to increase their profit margins through variations and claims for additional work.406

Only half of the contracts surveyed had mechanisms in place to ensure that value for money is maintained over the lifetime of a project. It is essential that PFI contracts have appropriate mechanisms in place, such as benchmarking, market testing, and open book accounting407.

To achieve value for money over the life of these contracts, the public sector clients (often referred to in this context as "authorities") need a strong contractual framework allied with

403 Para 3. Introduction. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty- second Report. Committee of Public Accounts. 404 The OGC is in the UK Treasury department. Its mission is to modernise procurement in government. The OGC represents the UK on procurement matters in Europe, in the WTO and other international fora. 405 Para 5. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. 406 Para 11. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. 407 Open book accounting is a feature of most strategic partnering contracts. As an important contribution and substance to the spirit of collaboration that underpins a strategic partnering contract, the partners agree the books of account will be open to inspection and examination to the business partners. The degree of access is determined through negotiation and discussion. The access must be sufficient to provide comfort but not so disruptive that it interferes with normal business. This is designed to demonstrate fairness and openness. This in theory will provide confidence on how the partners' monies are being disbursed and what profit/surplus/loss/deficit is arising. It is also protection against extravagance and expenditure behaviour that has been prohibited under the overarching partnership agreement. Open book accounting could disappoint in practice. Contractors' records are complex and there are many transfers between cost centres and management charges. In order for the open book accounting to be fully effective and understandable, there is a need to define how these charges are to be made beforehand or define mechanisms that can be monitored more easily. If a contract is managed through a special purpose vehicle that only deals with the PPP contract, open book accounting is likely to be more effective.

LN1:#20065849 189 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 190 good relationship skills in order to foster a spirit of partnership with their private sector partners. 408

Pre-contract appraisal and post-implementation reviews

The PAC said it had seen no rigorous assessment of value for money on PFI contracts in force, or empirical evidence as to whether they are good value for money or not.409 There are 400 PFI contracts now in progress with many more contracts being negotiated. Departments need to analyse rigorously whether their PFI projects are delivering the quality of customer service and value for money expected when the contracts were let.

Every pre-contract appraisal of any substance should indicate how the proposals concerned will be evaluated after completion and how the results of the evaluation will be disseminated.410

Post-implementation reviews are particularly important for projects where perceived value for money has declined since contract letting. Departments need to identify whether such a decline reflects errors of judgement by the authority when letting the contract, the contractor failing to deliver the service as promised, short term problems during the early period of the service delivery, or other factors such as high charges for additional services.

Abuse of contract changes

There is a risk that if a contractor builds high rates of return into the contract, it will be more expensive than if undertaken in the public sector.411 PFI contracts often contain specific procedures for the parties to vary the deal. Authorities need to watch that change procedures are not abused as a covert means for increasing the profit margins of the contractors.

Bail-outs

Contractors should expect to lose their investment in PFI projects when things go wrong and to be rewarded reasonably when things go well. If contractors successfully manage the risks that have been allocated to them and deliver the required services, then they will expect to earn rewards commensurate with the level of risk they have borne. But if they fail to manage the risks they have taken on, then they should expect that part or all of their equity investment in the project may be lost.

408 Paras 1 & 2. Introduction. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. 409 Parker & Hartley make an even stronger critique at p. 23 of their article: “The MoD claims that PPP/PFI have resulted in savings, but the supporting evidence has been sparse (this is consistent with the findings for other PPP/PPI initiatives). There is much evidence on the capital value of PFI projects and a general claim that PPP contracts have resulted in cost savings of between 5% and 40% compared with the public sector comparator (MoD, 1999, p7). However, no indication is given of the cost base and time-period over which these savings apply (eg. is the 40% saving on a sum of £10 million or £100 million each over 30 years?). Also, the savings are estimates expected over a long contract period where events can change so that the estimated savings might not be realised. Moreover, the economic basis of any cost savings from PFI needs careful scrutiny, distinguishing genuine efficiency improvements from ideological arguments and the MoD’s enthusiasm for the initiative. If PFI is to lead to genuine efficiency improvements, it has to result in lower costs over the project’s life cycle. Since the government can borrow at lower interest rates than the private sector, the economic advantages of PFI have to be in more efficient management during construction of the project and/or in lower operating costs from private sector management.” 410 Para 4. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. 411 Para 6. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts.

LN1:#20065849 190 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 191 The public sector authority should not insulate the contractor from the consequences of the risks it has been paid to take on. The public sector should certainly not reward private sector failure by agreeing to reduce the risk of the contractors losing their equity investment when the private sector has not delivered. 412

The risk of failure

The transfer of risk inherent in a PFI deal cannot protect the authority from the risk that the private sector simply fails to deliver what may be a key public service. It is essential that the authority actively manages this ultimately untransferable business risk.

Sharing the benefits of refinancing

The survey showed a very low proportion of authorities, just 15 per cent, with arrangements to share in refinancing gains. Refinancing can give rise to excessive returns to the private sector from PFI deals. Authorities should look towards a 50:50 share of refinancing gains and retain the right to approve any refinancing.413 Authorities should have contractual rights to share in refinancing gains.

Understanding the risk management systems of partner organisations

The UK government’s approach to risk transfer has evolved in recent years. For example, government guidelines (guidance) now talk about optimum or appropriate risk allocation rather than maximising risk transfer to the private sector in PFI deals.414 In any event, it is not possible to transfer all risks, such as the political risk of failure. This points to the importance of working in partnership and highlights the need for sound management arrangements. Current PFI guidance points out that, to obtain value for money, transferred risks need to be within the control of the partner organisation, otherwise it will seek to charge a premium for taking it on.415

The Parliamentary Public Accounts Committee (PAC) has highlighted the need to improve understanding of the risk management systems of partner organisations, both in terms of confirming quality and in terms of having an integrated approach. The Prime Minister’s Strategy Unit recommends use of a risk management standard as the basis for benchmarking and accrediting partners’ risk management arrangements. The SU recommends that, where responsibility for risk is transferred to a partner organisation, government departments should take particular care to ensure that accountabilities are clearly established, procedures for escalating risks are agreed, and capacity maintained to manage and monitor performance and to take early action in the event of difficulty. 416

Need for independent monitoring

412 Para 1. Detailed conclusions and recommendations. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. 413 Para 9. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. BT, for one, seems to be of a different in view. In a Memorandum dated 12 November 2001 submitted to the Select Committee on Treasury Minutes of Evidence, BT said that “refinancing deals are seen by public sector buyers as a means of getting their hands on any proven profit stream, even if the department concerned did not want to share in the risk at the outset of the initial project.” When questioned further by the author about this comment, BT responded that , “the degree to which profits can be shared will depend on a number of other variables within the deal. These too are changing as contractors, banks and the public sector gain experience over time.” e-mail from Janet Williams, BT, 24 Jan 2003. 414 p. 50, Strategy Unit Report on Risk. 415 pp. 64-5, Strategy Unit Report on Risk. 416 pp. 65, Strategy Unit Report on Risk.

LN1:#20065849 191 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 192 Having entered into the contracts, authorities were not likely to admit that they had got it wrong. 417 That being the case, there is a need for independent monitoring of contracts.

Staff continuity

Forty-seven per cent of authorities surveyed by the National Audit Office transferred less than a quarter of the staff employed on the contract procurement team to the contract management team. A number of authorities and contractors said they had experienced problems because of the lack of staff continuity within each other's contract management teams. The OGC said it strongly encouraged continuity between those involved up to the point of contract award and those involved post contract award. If there was loss of memory about what had led to particular agreements in the negotiations, then it must increase the risk that the partnering arrangement would not get off to a good start.418

Staff training

Staff responsible for managing PFI projects must be equipped with the appropriate skills as distinct from the skills needed to negotiate deals at the outset. 419

417 Para 2. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. 418 Paras 25 & 26. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty-second Report. Committee of Public Accounts. Memory loss simply adds to an almost inevitable risk inherent in any PPP, i.e., the risk that one or other of the parties to a deal will exploit his or her information advantage. Where buyers and suppliers have imperfect information when contracting, contracts cannot be optimal in a full information sense. It is difficult to write complete contingent claims contracts (allowing for uncertain events) especially where contracts cover a lengthy period of time, technologies and costs are inherently uncertain or the economic environment is in a state of flux. Imperfect information enables parties to a contract to operate opportunistically exploiting any information asymmetry (e.g. about the true costs or quality of supply). The result of opportunistic behaviour may be adverse selection, the ex ante choice of an inferior option, or moral hazard, increasing the ex post risk that one party will exploit the terms of the contract to the disadvantage of the other party. For example, changes in specification have been used by contractors as an excuse for raising prices and profits under government contracts. See pp. 6-8, Parker & Hartley. 419 Para 5. Introduction. Managing the Relationship to Secure a Successful Partnership in PFI Projects. Forty- second Report. Committee of Public Accounts.

LN1:#20065849 192 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 193

ANNEX 3

RISK MANAGEMENT

1. THE PRIVATE SECTOR

As PFI authorities should understand the risk management practices of those who take on PFI projects, it is useful to understand what is expected of (listed) companies with regard to risk management.

In 1998, the London Stock Exchange issued a document, known as the “Combined Code”, which sets out the Principles of Good Governance and Code of Best Practice. The Combined Code was drawn up on the basis of reports submitted by three committees, namely the Cadbury, Greenbury and the Hampel Committees.420 Under Rule 12.43A (Code of Corporate Governance), companies incorporated in the United Kingdom are required to include in their Annual Reports a statement furnishing, inter alia, details of their compliance with the provisions of the Code.

In September 1999, the Institute of Chartered Accountants in England & Wales published Internal Control: Guidance for Directors on the Combined Code, otherwise known as the Turnbull Report, which was prepared by an Internal Control Working Party, the chairman of which was Nigel Turnbull. The Report deals specifically with risk management. The guidelines apply to any risks that might be significant to the business achieving its objectives. These risks will naturally vary from company to company and it is the board of directors' explicit responsibility to identify them.

The Turnbull guidelines are intended to help the directors of listed companies set up a sound internal control system to manage significant risks facing their business. The guidelines cover issues including:

• types of risk that need to be controlled;

• what the control system needs to include;

• keeping the control system up to date;

• responsibilities of the board of directors; and

• significant risks facing a business.

As a result of the Combined Code and the associated Turnbull guidance, for the first time, corporate risks such as:

• capital investment losses on major projects;

• natural disasters;

420 Cadbury, Adrian, et al, "The Financial Aspects of Corporate Governance", London Stock Exchange: London, December 1992. Study Group on Directors’ Remuneration (Greenbury Report), "Final Report", London Stock Exchange: London, July 1995. Committee on Corporate Governance (Hampel Report), "Final Report", London Stock Exchange: London, January 1998. London Stock Exchange (LSE), "Hampel: The Combined Code", London Stock Exchange: London, June 1998.

LN1:#20065849 193 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 194 • loss of key suppliers;

• sabotage and other wilful acts of destruction are officially recognised as potentially damaging to the corporate strategy, and therefore need to be managed. Listed companies now have to conduct formal risk assessments and implement appropriate risk control measures.

In a foreword to the Turnbull Report, the London Stock Exchange said that it welcomed the publication and that it was “consistent with both the requirements of the Combined Code and of the related Listing Rule disclosure requirements, and clarifies to boards of directors of listed companies what is expected of them.”421

Principle D.2 of the Code states that “The board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.”

Provision D.2.1 states that “The directors should, at least annually, conduct a review of the effectiveness of the group’s system of internal control and should report to shareholders that they have done so. The review should cover all controls, including financial, operational and compliance controls and risk management.”

A company’s objectives, its internal organisation and the environment in which it operates are continually evolving and, as a result, the risks it faces are continually changing. A sound system of internal control therefore depends on a thorough and regular evaluation of the nature and extent of the risks to which the company is exposed. Since profits are, in part, the reward for successful risk-taking in business, the purpose of internal control is to help manage and control risk appropriately rather than to eliminate it.422

In determining its policies with regard to internal control, and thereby assessing what constitutes a sound system of internal control in the particular circumstances of the company, the board’s deliberations should include consideration of the following factors:

• the nature and extent of the risks facing the company;

• the extent and categories of risk which it regards as acceptable for the company to bear;

• the likelihood of the risks concerned materialising;

• the company’s ability to reduce the incidence and impact on the business of risks that do materialise; and

• the costs of operating particular controls relative to the benefit thereby obtained in managing the related risks.423

When reviewing reports during the year, the board should:

• consider what are the significant risks and assess how they have been identified, evaluated and managed;

421 The Listing Rule refers to the London Stock Exchange Listing Rules. 422 p. 5, Turnbull Report. 423 p. 6, Turnbull Report.

LN1:#20065849 194 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 195 • assess the effectiveness of the related system of internal control in managing the significant risks, having regard, in particular, to any significant failings or weaknesses in internal control that have been reported;

• consider whether necessary actions are being taken promptly to remedy any significant failings or weaknesses; and

• consider whether the findings indicate a need for more extensive monitoring of the system of internal control.424

In its narrative statement of how the company has applied Code principle D.2, the board should, as a minimum, disclose that there is an ongoing process for identifying, evaluating and managing the significant risks faced by the company, that it has been in place for the year under review and up to the date of approval of the annual report and accounts, that it is regularly reviewed by the board and accords with the guidance in this document.425

The Turnbull Report contains an Appendix with some questions which the board may wish to consider to assess the effectiveness of the company’s risk and control processes. Among them are these:

• Are the significant internal and external operational, financial, compliance and other risks identified and assessed on an ongoing basis? (Significant risks may, for example, include those related to market, credit, liquidity, technological, legal, health, safety and environmental, reputation, and business probity issues.)

• Does the board have clear strategies for dealing with the significant risks that have been identified? Is there a policy on how to manage these risks?

• Are authority, responsibility and accountability defined clearly such that decisions are made and actions taken by the appropriate people?

• Are there established channels of communication for individuals to report suspected breaches of laws or regulations or other improprieties?

• Is there appropriate communication to the board (or board committees) on the effectiveness of the ongoing monitoring processes on risk and control matters?

2. THE PUBLIC SECTOR

The most recent and certainly one of the most complete reports on risk management in the UK public sector is that of the Strategy Unit (which is attached to Prime Minister’s Office. It was formerly called the Performance and Innovation Unit). Its remit was to look broadly across the whole of government’s involvement in managing risk.426 The report makes recommendations for government action to improve its handling of risk. In putting together its report, the Strategy Unit surveyed board members and risk experts both in government and the private sector.427

424 p. 9, Turnbull Report. 425 p. 11, Turnbull Report. 426 p. 5, Strategy Unit Report on Risk. 427 From its survey (see pp 18-9), the SU found that: the private sector is much stronger in terms of senior management sponsoring, receiving and communicating results of risk reviews; • there was more evidence of the private sector having rehearsed response plans and having rapid reaction teams in place;

LN1:#20065849 195 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 196 2.1 Risks

The Strategy Unit Report does not define risk, at least not directly, although it does give a number of good examples, in addition to commending the list of risks identified by the UK Treasury department. Instead, the SU Report says there are no wholly reliable formulae for defining risk.428 The Oxford English Dictionary, obliged to define it, defines risk as “hazard, danger, exposure to mischance or peril”. The Treasury defines risk more elaborately as “the uncertainty of outcome, within a range of exposure, arising from a combination of the impact and probability of potential events.”429

Undoubtedly, there are many ways to define risk, and some degree of risk is faced daily by every one of us and by every organisation. Indeed, as the UK Treasury puts it, some amount of risk taking is necessary – the only way to avoid risk is to do nothing at all which is guaranteed to ensure that nothing is achieved.430

The way in which risk is defined might also depend on whether you come from the private sector or the public sector. A company can go bankrupt, which is less likely for a government. Private markets are characterised by competition, by profit incentives and by the capital market which provides a threat of take-over and bankruptcy. Government departments are not subject to competition, nor do their personnel share in any profits from efficient behaviour or experience losses from poor performance, and they cannot be made bankrupt or taken- over. Although the risk(s) faced by each sector differ to some extent, they do come together in PPP/PFI deals.431

It is impossible to identify every risk – there will always be the X-factor, the unknown, the unexpected (see also Annex 4), but still some effort needs to be made to identify risks, especially the most likely. No common checklist of risks has yet developed although one could do worse than refer to the UK Treasury’s “Orange Book” which identifies a good number of risks. Its list is reproduced here for ease of reference.432 The table does not claim to be comprehensive.

CATEGORY OF RISK

External

1. infrastructure relating to infrastructures such as transport systems for staff, power supply systems, suppliers, business relationships with partners, dependency on the Internet and e-mail 2. economic relating to economic factors such as interest rates, exchange

• the private sector’s responses indicated that it was much more active and competent than the public sector in managing opportunities and innovation; • government respondents recorded low scores on risk management skills and how they were valued. Many thought that the organisation had not invested in adequate skills, resources and training, and that the identification, assessment and management of risk and innovation were not a significant part of performance appraisal. • government risk management is too often judged, both by practitioners and others, to fall short of expectations and best practice. 428 p. 9, Strategy Unit Report on Risk. 429 p. 14, Orange Book. 430 p. 2, Orange Book. 431 It should also be noted that the provisions of the Turnbull Report have been adapted to the public sector, resulting in Statements of Internal Control (SIC) being introduced by the Treasury in December 2000. See p. 22, Strategy Unit Report on Risk. 432 p. 5, the Orange Book.

LN1:#20065849 196 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 197 rates, inflation 3. legal and relating to the laws and regulations which if complied with regulatory should reduce hazards (e.g., Health and Safety at Work Act) 4. environmental relating to issues such as fuel consumption, pollution 5. political relating to possible political constraints such as change of government 6. market relating to issues such as competition and supply of goods 7. “Act of God” relating to issues such as fire, flood, earthquake. Financial 8. budgetary relating to the availability of resources or the allocation of resources 9. fraud or theft relating to the unproductive loss of resources 10. insurable relating to potential areas of loss which can be insured against 11. capital relating to the making of appropriate investment decisions investment 12. liability relating to the right to sue or to be sued in certain circumstances Activity 13. policy relating to the appropriateness and quality of policy decisions 14. operational relating to the procedures employed to achieve particular objectives 15. information relating to the adequacy of information which is used for decision making 16. reputational relating to the public reputation of the organization and consequent effects 17. transferable relating to risks which may be transferred or to transfer of risks at inappropriate cost 18. technological relating to the use of technology to achieve objectives 19. project relating to project planning and management procedures 20. innovation relating to the exploitation of opportunities to make gains Human Resources 21. personnel relating to the availability and retention of suitable staff

22. health and safety relating to the well-being of people

Still other risks can be identified (perhaps by another name), as follows: manufactured risks, which spring from the increasingly rapid pace of development of new science and technology. These require governments and regulators to make judgements about the balance of benefit and risk across a huge range of technologies.

LN1:#20065849 197 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 198 systemic risks, which spring from distant events arising from the greater connectedness of the world, an integrated global economy, communications system and a shared environment. Economic crises in other countries, attacks on IT networks, diseases carried by air travellers, the indirect impact of civil wars and famines, the events of 11 September 1991 have increased exposure to catastrophic events elsewhere.433 non-traditional risks, which spring from those traditionally managed by the risk management or treasury departments. An EIU Report on Enterprise Risk Management published in 2001 identified the top three from an executive survey as:

• customer loyalty • competitive threats • operational failure.

The main categories of risk in capital works projects have been established as:

• design and construction; • commissioning and operating; • demand; • residual value; • technology/obsolescence; • regulation; • project financing; • contractor default • refinancing.434

As the above shows, the nature and range of risks is very wide indeed, and it behoves every decision-maker to manage risk.

2.2 Risk management

The Strategy Unit Report defines risk management as covering all the processes involved in identifying, assessing and judging risks, taking actions to mitigate or anticipate them, and monitoring and reviewing processes. Or as the OGC defines it - ensuring that the organisation makes cost effective use of a risk process. Risk management requires: processes in place to monitor risks; access to reliable up-to-date information about risk; the right balance of control in place to deal with those risks; decision-making processes supported by a framework of risk analysis and evaluation.435

There has been and continues to be considerable debate on the extent to which the practices of the private sector can be applied in the public sector and vice versa. The Strategy Unit project team was of the view that, while there are significant differences between the sectors, they can learn from each other and that best practice can and should be shared.436

Like the Turnbull Report, the SU Report argues that risk management needs to be embedded in and made a part of decision-making throughout an organisation. It identifies three main

433 P. 5, Strategy Unit Report on Risk. 434 P. 64-5, Strategy Unit Report on Risk. 435 Annex 2, Strategy Unit Report on Risk. 436 Annex 5, Strategy Unit Report on Risk.

LN1:#20065849 198 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 199 levels of decision-making as strategic, programmatic and operational.437 At each level, the nature of the risks and the depth of uncertainty will differ.438 Although each of these levels has distinct characteristics, some common approaches to risk management can be prescribed. The Report identifies the key elements of risk management as the following439:

Identification

What could happen? Regular reality checks are needed, involving rigorous assessment of trends, possibilities, dangers, their likelihood and impact (horizon scanning). Often this needs to involve people without a direct stake in the specific area of work itself to ensure objectivity. Wherever possible, informal channels of information as well as formal ones need to be used. Risks have to be identified and assessed, with responsibility and accountability allocated and clear.

Assessment440

What matters? Having established what could happen, organisations need to make judgements about their importance and the value about the desirability or otherwise of different outcomes, taking account, for example, of the importance of the reliability of a service, the advantages to be gained from an innovation or the place of an activity in the broader contract between the state and citizens. Some risks (e.g., financial risks) lend themselves to quantification; risk assessment is less well established for other risks, where the role of judgement must be greater. Most risks cannot be eliminated altogether, and risk management involves making judgements about what level of risk is acceptable – risk tolerance or risk appetite. 441 There should be an explicit appraisal of risks, as well as benefits and costs, in all main decision processes. Risk management plans should be underpinned by an assessment of resilience to threat, and actively develop their resilience to ensure there is the capacity to respond flexibly to potential risk.442

Action

What can be done? Having established what matters, organisations need to plan ways to avoid, mitigate, anticipate and otherwise cope with the potential risk, and to plan for uncertainty. In some cases, contingency planning will be essential. In others, it may be important to put in place capacity to cope with unforeseeable events. Four courses of action are possible: transfer; tolerate; treat; and terminate.443 Resilience to major disruptive challenges implies consequence management (crisis management when serious risks are realised). 444

Review

What has happened? Having taken initial action, organisations need to assess whether it has had the intended effect, whether the assessment of risks needs to change and whether

437 p. 14, Strategy Unit Report on Risk. The three main levels of decision-making correspond to the three main levels of risk management identified by the SU, as follows: (1) strategic/corporate/ external (2) financial/ asset management (3) delivery (both operational and project/ programme risks, including resourcing risks). 438 p. 28, Strategy Unit Report on Risk. 439 p. 6 et seq., Strategy Unit Report on Risk. 440 Annex 2 of the SU Report defines risk assessment as the process and approach used to prioritise and determine the likelihood of risks occurring and their potential impact on the achievement of objectives. 441 p. 49, Strategy Unit Report on Risk. 442 p. 105, Strategy Unit Report on Risk. 443 p. 50, Strategy Unit Report on Risk. Cf. the Treasury’s “Orange Book”. 444 p. 52, Strategy Unit Report on Risk. Cf. the Treasury’s “Orange Book”.

LN1:#20065849 199 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 200 further action is needed. Gateway Reviews were introduced by the UK government in 2001 as checkpoints in the life of projects and programmes. They provide a thorough review, and sign- off, before work is allowed to proceed to the next stage of development. Each Gateway Review should be underpinned by an explicit assessment of the risks and opportunities of proceeding, informed where necessary by the views of all relevant stakeholders. This should involve risk/hazard identification, assessment, and judgement of risks drawing on empirical evidence and the public context, and development of options for managing the risks (mitigation actions and contingency plans). 445

Communication

Decision-makers need to communicate (in the two-way sense of the word) with those potentially affected by the risks and with those who can help manage the risks. Organisations need to make judgements in as open a way as possible about the nature of risk and how responsibilities should be allocated, recognising that there will always be some unavoidable uncertainty.446 Communication will be more effective if stakeholders (including the public) are made aware of the approach to handling risk and uncertainty, so that they are better informed about risks, their consequences and trade-offs. 447

* * *

In summary, risk management requires processes in place to monitor risks; access to reliable, up-to-date information about risk; the right balance of control in place to deal with those risks; and decision-making processes supported by a framework of risk analysis and evaluation.448

2.3 Risk management strategy

Throughout the SU report, one can find the key elements of a risk management strategy, as follows:

Senior management should take the lead in risk management. Application of risk management concepts should be integrated into decision-making at the highest level, should be visible and communicated to staff at all levels. There should be incentives for effective risk management, linking them to greater financial or management autonomy.449 Top management should drive the improvements to risk management and foster a culture that fully supports well managed risk-taking.

There should be greater awareness of, and responsibility for, risk outside finance and audit functions.450

Roles and responsibilities for handling risk should be clearly identified as should be the aims and principles used to guide actions in handling risk. Responsibility for handling risks should lie with those who can best manage them.451

445 pp. 33-4, Strategy Unit Report on Risk. See also the OGC Web site: www.ogc.gov.uk, where it says that the Gateway Review Process aims to improve the management of projects through the use of independent peer reviews. New procurement projects are subject to Gateway Reviews. The process applies equally for those organisations that already have strategic partnering arrangements in place. The Gateway Process examines a project at critical stages in its lifecycle to provide assurance that it can progress successfully to the next stage. It is designed to be applied to projects that procure services, construction/property, IT-enabled business change projects and procurements utilising framework contracts. 446 p. 9, Strategy Unit Report on Risk. 447 p. 26, Strategy Unit Report on Risk. 448 p. 7, Strategy Unit Report on Risk. 449 p. 24, Strategy Unit Report on Risk. 450 p. 17, Strategy Unit Report on Risk.

LN1:#20065849 200 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 201 Decision-makers, if not all staff, should have the skills to identify and assess risks and take the action necessary to manage them. All staff should receive appropriate training.452

The risk management strategy should ensure risk ownership is aligned with accountability for delivery and authority to act – and the extent to which placing responsibility on those accountable for results needs to be supported by a central focus of expertise. It should also put in place reporting arrangements in order to feed up to the board the results of risk assessments.453

All major decisions about programmes and policies should take explicit account of risks and opportunities. Those involved in decision making should be supported by professional expertise.454 Decision making needs to be underpinned by investment appraisal focused on benefits, costs and risks, explicitly identifying and assessing risks and developing risk mitigation plans for priority risks from conception to appraisal and into execution. 455

Non-executive directors should play an important part in helping to identify strategic risk and provide an independent perspective on the level of risk faced and the adequacy of measures to address risk. 456

Departments should assess the strengths and weaknesses of risk management systems in partner organisations.457 In the GALILEO context, this means that the EC or the Joint Undertaking should assess the risk management of the prospective concessionaire. By the same token, the prospective concessionaire might wish to do the same, especially with regard to how EC decisions might subsequently affect the concessionaire and to what mechanisms will be put in place to regulate and instruct the concessionaire.

Getting the culture right is essential to managing risk effectively within organisations.458 The underlying values that were found to contribute towards building an effective risk management culture within organisations were:

• recognising individual responsibility and achievement; • delivering results; • accepting new ideas and ways of doing things; • rigorous and evidence-based analysis and judgements;

451 p. 27, Strategy Unit Report on Risk. 452 p. 18, Strategy Unit Report on Risk. 453 p. 57, Strategy Unit Report on Risk. 454 p. 27, Strategy Unit Report on Risk. 455 p. 37, Strategy Unit Report on Risk. 456 p. 105, Strategy Unit Report on Risk. 457 p. 17, Strategy Unit Report on Risk. 458 p. 95, Strategy Unit Report on Risk.

LN1:#20065849 201 GALILEI REF : Gali-Mbank-dd121/122 DATE : 24/07/03 Galileo Organisational Scenario modelling ISSUE : 2.0 PAGE: 202 • challenging established assumptions and procedures; • openness, transparency and honesty; • understanding the needs of stakeholders and customers; • anticipating and sharing problems; and • learning from mistakes and avoiding a culture of blame. 459

459 p. 93, Strategy Unit Report on Risk.

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