PUBLIC TRANSPORT PARTNERSHIPS

An Overview of Passenger Rail Franchising in

March 2005

Department of Infrastructure PUBLIC TRANSPORT PARTNERSHIPS

An Overview of Passenger Rail Franchising in Victoria

March 2005

Public Transport Division Department of Infrastructure

© State of Victoria 2005 Published by Public Transport Division Department of Infrastructure 80 Collins Street, March 2005 www.doi.vic.gov.au This publication is copyright. No part may be reproduced by any process except in accordance with the provisions of the Copyright Act 1968. Authorised by the Victorian Government, 80 Collins Street, Melbourne. Minister’s Foreword

In February 2004, after the failure of the original privatisation framework, the Victorian Government entered into new franchise agreements with Melbourne’s public transport companies, and Connex.

These partnership agreements find the balance between government support for public and the operational expertise provided by experienced private rail operators.

Almost one year on, the new arrangements are running smoothly, providing stability across the public transport system and giving a solid foundation for a range of improvements in service delivery.

Some of the other benefits to passengers that stem from these agreements include:

• Additional front-line customer service staff; • Increased security patrols; • Improved driver training programs; • All night New Year’s Eve services; • Additional rolling stock; and • Improved standards for the upkeep of transport facilities.

The key themes of this summary report include the background to the failure of the original contracts, the renegotiations, the nature of the new partnership agreements and the challenges of the refranchising process.

You can obtain the latest information about Melbourne’s public transport by visiting www.doi.vic.gov.au/transport

I commend this report to you.

Peter Batchelor MP Minister for Transport State Government of Victoria,

March 2005

Department of Infrastructure 2 Purpose of this document

This document has been prepared by staff within the Public Transport Division of the Department of Infrastructure to assist interested parties to understand the history, processes and rationale associated with the refranchising of metropolitan train and tram services undertaken between 2002 and 2004. In particular, it examines the reasons behind decisions made on contract design.

While this document is intended to be comprehensive and accurate, it is not a substitute for a review of the legal contracts or detailed documentation retained by the Department of Infrastructure on the policy, process and Offer evaluation issues associated with the refranchising process. In particular, no action of any sort should be undertaken in reliance of information in this document.

This document is divided into five main sections:

1. Background – a history of the structure of public transport in Victoria and the original franchising process, discussion of what went wrong and preparation for refranchising.

2. The Refranchising Process – a summary of the procedures and strategy adopted by the Refranchising Team in managing the amalgamation and refranchising of the metropolitan train and tram businesses.

3. The Outcome – an overview of the new industry structure, including details of the Yarra Trams, Connex and structures.

4. Contract Design – a detailed discussion of the processes and requirements set out in the franchise contracts.

5. The Legal Framework – an overview of the key franchise documents and how these interact.

Department of Infrastructure 3 CONTENTS

Chapter 1: Background...... 5 Early history ...... 5 Recent history and prelude to privatisation...... 5 The 1999 franchising process ...... 6 The original franchise arrangements...... 7 What went wrong ...... 8 Settlement Deeds and the IOAs...... 12 Chapter 2: The Refranchising Process ...... 15 Retender, renationalise or renegotiate? ...... 15 The Government’s refranchising objectives...... 17 Foundations of refranchising...... 18 Structure of the Refranchising Process ...... 22 Documents provided to franchisees ...... 24 Public Sector Benchmark...... 26 Probity and information gathering...... 28 Negotiation...... 31 Evaluation of Offers ...... 31 Chapter 3: The Outcome ...... 35 Yarra Trams’ franchise structure ...... 35 Connex’s franchise structure...... 36 Metlink ...... 40 Summary of roles and responsibilities...... 45 Chapter 4: Contract Design ...... 47 Operations and service delivery ...... 47 Incentive mechanisms...... 55 Risk and financial management ...... 59 Asset management ...... 65 Rolling stock ...... 75 Projects and project delivery ...... 78 Business planning and reporting ...... 85 Contract variations ...... 88 Payments...... 88 Metlink ...... 91 Chapter 5: The Legal Framework ...... 95 Transaction Documents ...... 95 Metlink Agreements ...... 97 Direct Agreements ...... 98 Enforcement of contracts ...... 99 Termination arrangements ...... 100 Appendix 1: Financial Summary ...... 101 Appendix 2: Risk Allocation Table ...... 103 Appendix 3: Key Projects ...... 115 Appendix 4: List of Documents ...... 119 Appendix 5: Glossary of Terms...... 123

Department of Infrastructure 4 Chapter 1: Background

1.1 Early history

Melbourne’s first railway line opened between Flinders Street and Sandridge (now Port Melbourne) in September 1854, and over the next decade the railway spread across the city area. Cable trams appeared in Richmond in 1885, and the first electric tram began operation between Box Hill and Doncaster in 1889. By the early 1900s, Melbourne had a comprehensive train and tram network, and this began to shape the city’s expansion, with growth occurring along the rail lines. Electrification of the train system was completed in 1929, and the last cable tram ran in 1940.

After World War 2, when other countries were phasing out their trams in favour of , Melbourne became one of only a small number of cities around the world to retain its system. However, higher car ownership during the long post-war boom, and increasing development in the outer suburbs and in the spaces between railway lines, led to a steady decline in the public transport’s market share. While the road and freeway networks expanded, the train and tram networks were stagnant.

By the 1980s the decline in market share was beginning to flatten out as planners and Governments became increasingly aware of the benefits of reducing car use by enabling and encouraging people to use mass transit instead. The decade saw the opening of the and several tram extensions, as well as the introduction of large numbers of new train and tram vehicles.

1.2 Recent history and prelude to privatisation

In 1983 the Metropolitan Transit Authority (commonly known as the Met) was created. This subsumed the metropolitan train operations of and the tram operations of the Melbourne Metropolitan Tramways Board. Victorian Railways’ regional train operations were taken over by another new body, the State Transit Authority (trading as V/Line).

Six years later, in 1989, the Metropolitan and State Transit Authorities were merged to form the Public Transport Corporation (PTC). The Met and V/Line names were retained for metropolitan and regional operations respectively, but the PTC operated both from a central structure under public ownership.

In 1992 the Kennett Government was elected and set about an ambitious and far-reaching program of reforms. During the mid-1990s public transport was characterised by radical cost-cutting. The PTC’s business was sold off, stations were de-staffed and conductors removed from trams as the PTC’s workforce fell from 18,000 to 8,400 between 1992 and 1997. By the end of the reform process the PTC’s operating costs had been reduced by almost $250 million per annum.

By late 1997 the Government had formed the view that further improvements in efficiency and service delivery could only be achieved through radical restructuring, and it was decided to proceed with privatisation of the public transport system (a decision which was precipitated by the transport union’s strike during the 1997 Grand Prix). Because the passenger rail businesses were heavily dependent on public funding, it was not feasible to adopt the kind of “asset sale” approach pursued in other privatisations (eg, the energy sector) where public ownership gave way to light-handed independent regulation. Public transport was so heavily loss-making that in order to secure its continued operation it required not only financial support but continuing, detailed oversight from Government. For this reason, a franchising approach was selected.

The Transport Reform Unit (TRU) was set up within Treasury to oversee the full privatisation of Victoria’s passenger and freight rail networks. In July 1998, the operational area of PTC was disbanded and split into five separate corporatised businesses in preparation for privatisation. These were:

• Met Train 1 – named Bayside Trains;

• Met Train 2 – named Hillside Trains;

Department of Infrastructure 5 • Met Tram 1 – named Swanston Trams;

• Met Tram 2 – named Yarra Trams; and

• V/Line Passenger.

In addition, two new corporations were set up:1

• V/Line Freight Corporation, which was subsequently sold in May 1999 to Rail America (and initially traded as Freight Victoria, subsequently changing to in February 2000); and

• Victorian Rail Track Corporation (VicTrack), which would own and lease out metropolitan train and tram infrastructure.

1.3 The 1999 franchising process

The Government’s aims for the original franchising process were:

• to secure a progressive improvement in the quality of services available to public transport users in Victoria;

• to secure a substantial and sustained increase in the number of passengers using the public transport system;

• to minimise the long term costs of public transport to the taxpayer;

• to transfer risk to the private sector; and

• to ensure that the highest standards of safety were maintained at all times.

The franchising process was designed to meet these objectives, and was predicated on the assumption that going forward the Government’s role was to be reduced to that of a contract manager, and longstop in the event of a catastrophe. This objective of risk transfer was not qualified by any assessment of which party was best able to manage the risk.

A competitive tender was undertaken and drew a high level of interest from bidders around the world, particularly in Europe where the British privatisation process had been completed in 1997 and franchisees had subsequently experienced unprecedented levels of growth. The winning franchisees were:

• Bayside Trains – Group Australia (ultimately owned by National Express plc);

• Hillside Trains – Melbourne Transport Enterprises (trading as Connex and ultimately owned by Vivendi Environnement SA);

• Swanston Trams – National Express Group Australia;

• Yarra Trams – MetroLink (a partnership between SA and Transfield Services Ltd); and

• V/Line Passenger – National Express Group Australia.

Hillside Trains was subsequently rebranded as Connex, Bayside Trains as M>Train, and Swanston Trams as M>Tram. Yarra Trams and V/Line Passenger retained their trading names.

1 These corporatised businesses began operation on 1 July 1997.

Department of Infrastructure 6 The Government believed it had achieved all of its aims. In particular, substantially all commercial risks (including cost, revenue, operational performance, asset procurement and asset condition risks), had been passed to the private operators, and cost savings of $1.8 billion over the terms of the franchises were in prospect. These cost savings were to be achieved through a dramatic reduction in the level of Government base contract payments for the operation of train and tram services (ultimately reducing to almost zero in the final years of the contracts).

1.4 The original franchise arrangements

The franchise contracts were signed between the winning bidders and the State Government in 1999, and from 29 August 1999 Victoria’s public transport was in the hands of private operators. The key features of the franchise arrangements are outlined briefly below:

• 10 to 15 years in length – the contracts were relatively long (15 years for metro train, 12 years for tram, 10 years for V/Line) to ensure the franchisees had an incentive to put in place effective processes for the procurement of new rolling stock and investment in infrastructure works;

• vertical integration – unlike the British model, which had separate dedicated infrastructure and rolling stock companies, franchisees (except V/Line Passenger) were responsible both for above track (service delivery) and below track (infrastructure maintenance) operations. This avoided the problem of an under-incentivised network provider remote from end-users, and reduced contractual interfaces therefore reducing the scope for disputation and “buck-passing” when service was poor. Victorian infrastructure was leased to the franchisees and they were required to maintain assets to a standard that ensured their long term condition did not deteriorate;

• “competition by comparison” – the idea behind the two metro train and two tram companies was to encourage the poorer-performing business to strive to emulate the superior franchisee;

• Government base contract payments were locked in up-front, year by year;

• variable revenue allocation from a common pool, according to a quarterly survey of passenger ticket usage across the public transport system. All farebox revenue was paid into the Revenue Clearing House, a joint industry body which divided it between operators on the basis of the ticket usage derived from quarterly surveys;

• retention of multi-modal ticketing system (although franchisees could introduce their own tickets in addition to fares), and restrictions on fare rises to the level of inflation;

• specified minimum service levels and frequencies – the contracts prescribed minimum service standards to ensure there was no erosion of service levels by operators;

• financial incentives for improved punctuality and reliability – an Operational Performance Regime (OPR) gave bonuses for performance better than a set threshold, while franchisees paid penalties if performance was below the threshold. The target was set at a level that required a substantial improvement (20% or more) on historical PTC on- time performance, and became progressively more challenging, requiring steadily improving performance over time by the franchisees; and

• franchisees were required to procure around $1.1 billion worth of new rolling stock and to refurbish existing rolling stock. The Government provided funding for the new and refurbished rolling stock on a fixed-price basis (ie, the franchisees assumed the risk of cost escalation during delivery).

Department of Infrastructure 7 The Melbourne train and tram network in 2004

Train system: Tram system:

17 lines 26 main routes 371 route kilometres 242 route kilometres 209 stations (of which 67 premium) 1,740 tram stops 30,000 car parks at stations 261m average stop spacing 157 six-carriage trains 530 trams 1,850 weekday services 5,300 weekday services 16 million service kilometres per annum 9 million service kilometres per annum 131 million boardings per annum 131 million boardings per annum

Ticketing

Multimodal (train, tram and bus on one ticket) Zonal (3 zones with overlaps at the edges) Time-based (2-hour, daily, weekly, monthly, yearly tickets) Automated (with some off-system sales and staff sales at stations)

1.5 What went wrong

But just over three years after privatisation, the public transport system was in financial crisis. National Express had walked away from its contracts, leaving operation of M>Train, M>Tram and V/Line Passenger in the hands of Receivers, and Yarra Trams and Connex were also facing severe financial difficulties and, ultimately, insolvency.

Despite this, there were considerable achievements between 1999 and 2002:

• punctuality and reliability of services had improved overall by an average of 35%;

• the number of train and tram services running had been increased by almost 10% (mainly through growth in off-peak services);

• industrial peace had been maintained;

• almost $1.1 billion worth of new rolling stock was being delivered into service on time;

• $143 million of rolling stock refurbishments were progressing on time;

• new tram superstops had been constructed and four additional stations brought up to premium standard;

• extension of the Mont Albert tramline to Box Hill and the St Albans train to Watergardens (Sydenham) had been completed;

• customer satisfaction had increased from 61% before franchising to 68% in 2003 (average over all operators); and

• patronage was increasing at around 3% per annum (estimated to be about twice the rate achieved under public operation in the 1990s).

However, in spite of these positive achievements, the franchisees were facing huge financial losses if they continued under their contracts with the State. What had gone wrong?

Department of Infrastructure 8 In fact, a number of factors contributed to the financial unsustainability of the public transport franchises in Melbourne. These included:

• unrealistic assumptions by the bidders in relation to patronage growth and cost reduction (by far the most significant influencing factor);

• flaws in, and disputes over, the contractual arrangements;

• the poor performance of the ticketing system; and

• the introduction of the GST.

1.5.1 Unrealistic assumptions about patronage growth and cost reduction

The bidders made very ambitious forecasts about the patronage (and therefore revenue) growth and cost reductions possible in the new franchises under innovative private operation.

Forecast patronage growth Franchise over term of franchise Bayside Trains 84% Hillside Trains 64% Swanston Trams 40% Yarra Trams 57% V/Line Passenger 74% Overall 71%

These high forecasts were a partly a result of the buoyant growth rates in the UK rail industry at the time, and partly because of an intensely competitive bidding environment which led to “deal fever”. They were made by foreign bidders who had little local knowledge and who were basing their forecasts on experience of conditions in south-east England, where very high patronage growth was occurring at the time. Bidders failed to take account of the very different conditions in the Victorian transport industry, including:

• a strong culture of car use, and an urban form (and population density) not generally conducive to high levels of public transport use in the outer suburbs;

• an industrial relations environment which would require careful and astute management to achieve significant additional labour reform; and

• an industry that was already relatively efficient after five years of down-sizing and offered only limited scope for further cost reductions.

It simply wasn’t possible to replicate the British conditions in Victoria and reap huge cost reductions and patronage increases through changes to work practices and marketing. The franchisees had bid for fixed base contract payments from the State, and these reduced sharply after the first few years as revenue increases and cost reductions were forecast to kick in. When these didn’t eventuate, the payment reductions put the franchisees in a potentially dire financial position.

1.5.2 Contractual flaws and disputes

The franchise contracts borrowed heavily from the design of rail franchises overseas, particularly in the UK. However, they also included a number of new and innovative elements, and features appropriate to the different operating environment in Victoria.

Some of these contract design innovations worked, but several did not, and the resulting problems are outlined below. Many of these issues, while not financially crippling to the franchisees, made life more difficult and distracted the industry from dealing with more important matters.

Department of Infrastructure 9 • Revenue dispute

Under the Franchise Agreement and the Metcard Management Agreement, ticket revenue from all metropolitan public transport operations was pooled and distributed to train, tram and bus operators on the basis of quarterly ticket usage surveys. The surveys were designed to determine the services passengers were using, and to reward individual operators for increasing patronage on their services.

In practice, flaws in the survey methodology (including a small sample size and subjective reporting) led to considerable volatility in the revenue shares of individual operators from quarter to quarter and created a long-running dispute between them. Disputes began from the very first survey, and as farebox revenue growth stagnated it was easier for franchisees to argue over shares of the revenue pool rather than to work together to grow it. This consumed management time which could have been spent on, for example, marketing the system or improving ticketing arrangements.

• Settlement disputes

The franchisees raised a significant number of claims after franchise commencement, relating in large part to the original bidding process and transition. The State investigated these, in some cases resulting in payments to the franchisees. However, several years after the franchise contracts had been signed, issues were still being discussed. Many of the disputes did not get resolved until the Settlement Deeds and Interim Operating Agreements were negotiated (see Section 1.6).

• Passenger Growth Incentive regime

The Franchise Agreement included an incentive regime designed to reward franchisees for growing patronage (as reflected in farebox revenue), under which the State would make incentive payments to a franchisee whose farebox revenue was in excess of a specified threshold amount. However, the practical effect of this was simply to magnify the franchisees’ revenue shortfall when the expected patronage increases failed to materialise.

• Infrastructure maintenance regime

The innovative output-based infrastructure maintenance and renewal regime (based on condition indices) was designed to provide the franchisees with flexibility and incentives to be efficient. Unfortunately, the methodology used in assessing the condition of the infrastructure was fundamentally flawed, and the franchisees had no way of knowing whether their works were sufficient to meet the condition index targets or not. This is examined in detail in Section 4.4.1.

• Adshel and JCDecaux disputes

Shortly after commencement, two separate but related disputes arose in relation to exclusive advertising rights on tram shelters. These involved advertising companies Adshel and JCDecaux, as well as Yarra Trams, the PTC and the Department of Infrastructure. The disputes were to drag on for several years, diverting management time and attention and reducing the income flow available from advertising shelters.

• Other interoperator disputes

Since much of the key infrastructure used by the businesses (particularly for the train network) could not easily or cost-effectively be duplicated, several monopoly assets were leased to individual operators. Interoperator Agreements were established to ensure that the lessee of each asset provided the necessary services to the other businesses that required them – eg, City Loop track access, central city station access, Metrol, Electrol.

Many of these agreements were put together quickly at the end of the franchising process, and franchisees (particularly Connex and M>Train) complained that they were often unworkable and consumed a disproportionately large amount of management time. In

Department of Infrastructure 10 addition, interoperator agreements often failed to prevent disputes between operators over fault attribution in the event of delays (and subsequent OPR penalties).

1.5.3 Poor performance of the ticketing system

Multimodal ticketing was introduced to Melbourne in 1981, and three fare zones in 1989, both measures meeting with widespread approval. Automated ticketing was introduced in 1997 in the form of Metcard, and was significantly less popular and successful. As part of the reforms during the Kennett Government, automated fare issuing and collection was contracted to the OneLink consortium (comprising ERG, Mayne Nickless and Fujitsu). This was designed to bring Melbourne’s ticketing system up to modern international standards, as well as enabling the removal of large numbers of staff from the system (particularly from trams).

Unfortunately, the ticket delivery system, built on world-first technology, struggled from its inception (almost three years late). Public acceptance of the system was low, with anger at staff cuts, confusion at the new technology, and malfunctioning machines compounding the difficulties. A poorly designed contract meant that OneLink could continue to be in technical compliance with its contract even as hundreds of ticket machines across the system did not work properly.

Faulty ticketing equipment not only prevented passengers from buying tickets, but also undermined revenue protection – a significant problem when all the franchisees had bid on the basis of sharp reductions in fare evasion. Ticket machines also proved vulnerable to vandalism and theft, resulting in further revenue loss to the operators. In addition, despite the fact that the franchisees did not own or control them, ticket machine problems added to a poor passenger perception of the transport system overall.

During the first half of 2002, the Government and franchisees worked together to renegotiate the OneLink contract to replace the technically-driven definition of machine availability, with customer- defined availability, greatly improving the performance of the system. But by then significant damage had been done, and the franchisees were already behind on their revenue targets.

1.5.4 Introduction of the GST

The Commonwealth Government introduced a broad-based Goods and Services Tax (GST) of 10% on 1 July 2000. This had been planned by the Government for some time, however the franchising process was completed before the final form of the legislation was passed in Federal Parliament. At the time of bidding, franchisees were to take “tax reform risk” – ie, there would be no recourse to any compensation after the introduction of the GST.

Notwithstanding this, the GST was contemplated in the franchise contracts, with franchisees instructed to bid on the basis of a 5% GST. In order to make the GST as neutral as possible on franchisees, all base contract payments were to be indexed to a GST multiplier as well as CPI. To neutralise the GST’s effect on farebox revenue, a mechanism under the Franchise Agreement provided for the State to compensate franchisees on imposition of a GST greater than 5%, by either:

• allowing a one-off fare increase of the difference between the 5% allowed for in the bid and the actual GST (ie, 5%); or

• a corresponding adjustment to base contract payments; or

• some combination of the two.

The implicit assumption was that these options all had the same effect. However, this ignored the elasticity effect of an increase in fares on patronage (ie, increasing ticket prices would drive some passengers away).

In the event, the State chose to increase fares by 5% (although the practical effect was an increase slightly less than this, as fare increases round down to the nearest five cents). The result was two fare rises in six months, totalling over 13% (5% on 1 July 2000, followed by 8.3% on 1 January 2001, a figure which was also affected by the GST’s impact on inflation).

Department of Infrastructure 11 The reduction in patronage and farebox revenue resulting from the GST’s impacts on fare increases was estimated to be between $60 and $150 million over the term of the franchises (across all franchisees).

In addition to the elasticity effects, the imposition of the GST had an impact on the costs of the franchise businesses. Pre-bidding, this was estimated at a reduction in costs of 4% (because of the removal of indirect taxes), but in the end savings were around 2%. The total prospective cost of this to franchisees was estimated at up to $100 million (over the life of the franchises).

Around mid-2001, franchisees began to raise serious concerns with the Government about their financial viability. The Government was concerned that, if a franchisee became insolvent or walked away from its contract, there could be serious disruption for passengers.

Independent assessments of the franchisees’ financial positions undertaken in February 2002 suggested they were in dire trouble and could not remain solvent for much longer. Taken together, the franchisees had underperformed against their bids since commencement by $130 million, incurring losses of $19 million and requiring parent company support. Losses across all operators were forecast to rise to $420 million by the end of 2004.

1.6 Settlement Deeds and the IOAs

The Kennett Government’s aim had been a public transport system in which all key commercial risks were transferred to the private sector. Clearly this was no longer feasible in circumstances in which the operators’ very viability was under threat. With any contractual arrangements of this sort, the potential cost of guaranteeing that a business serve out its contract under any circumstances would be prohibitive. Therefore, under the franchise contracts, the Government could not prevent the franchisees’ parent companies from abandoning their Australian businesses by withdrawing financial support before the 10-15 year terms of their contracts had expired (although in such circumstances they would lose their Performance Bonds). With this in mind, the Government could either step in to sort out the mess or risk chaos in the public transport system when the operators inevitably went broke. Neither option was attractive, and difficult decisions were required.

1.6.1 Resolution of the revenue allocation dispute

As mentioned in Section 1.5.2 above, as late as 2001 the State still faced a large number of outstanding claims by the franchisees relating to the contractual closure of the franchise contracts and the first two years of operation. However, only a handful of these were material in their own right, and it was the major issues the Government chose to focus on first. In late 2001, high level discussions took place between senior officials and franchisees, culminating in a letter signed by all parties on 21 December which agreed a resolution to the revenue allocation dispute and two other outstanding claims. Revenue allocation would from then on be fixed according to agreed shares.

The letter also outlined a way forward to address the financial crisis facing the franchisees. It committed the franchisees to “open book” discussions with the Government, and set out a timetable for a franchise review process overseen by a Government “Franchise Review Task Force”.

1.6.2 The Franchise Review Task Force

The Franchise Review Task Force was made up of staff from Public Transport Division (PTD) and Department of Treasury and Finance (DTF), supported by external consultants – managerial, strategic, financial and legal. The objectives of the Task Force were to gain a thorough understanding of the extent and cause of the franchisees’ current and forecast under-performance, and to assess the options available to the Government for responding. The Task Force was also responsible for undertaking consequential negotiations with franchisees.

The Task Force reported to the Minister for Transport, and through him to a special sub-committee of Cabinet, the Rail Projects Cabinet Committee.

Department of Infrastructure 12 1.6.3 The 2002 Settlement Deeds

The first act of the Task Force was to invite franchisees to submit all their outstanding claims and disputes. It needed to clear the decks of long-running disputes so that both sides of the industry could focus on the big picture. It had to provide a stable foundation for the upcoming discussions on franchise viability, and to do this it needed to have a comprehensive list of all outstanding issues to ensure there would be no surprises in the future. This course of action also reduced the risk of future litigation against the State should negotiations break down. The franchisees were eager to comply with the request, and around 150 issues were put on the table, both old and new.

During early 2002, the Task Force worked with the franchisees to resolve as many disputes and claims as possible, and in March the Government signed Settlement Deeds with the franchisees. The Settlement Deeds resolved around half of the outstanding claims, resulting in payments to the franchisees totalling around $42 million. The Settlement Deeds also listed outstanding claims which had not been resolved, and stipulated that no new claims relating to the period from franchise commencement would be considered. This drew a line in the sand and provided a stable base for all parties to work from.

But the Settlement Deeds also established the framework and foundation for the wider negotiating process to come. They included provisions to:

• require the State and the franchisees to commit resources to the Franchise Review Process and to work in good faith to reach a resolution, in accordance with an agreed indicative timetable;

• double the value of the franchisees’ Performance Bonds (from $105 million in aggregate to $210 million) until the end of 2003 – the Performance Bonds could be drawn down by the State in the event that a franchisee defaulted, or walked away from its contract. Their doubling provided comfort to the Government that the franchisees were committed to the Franchise Review Process and dramatically reduced the risk of their walking away precipitately; and

• require franchisees to cooperate with the Government in the implementation of public transport initiatives, including the establishment of a public transport ombudsman, daily tickets on trams, renegotiation of the OneLink ticketing contract and the return of W Class trams (then out of service because of braking problems).

In short, the Settlement Deeds (like the Interim Operating Agreements to come after them) were designed to provide stability and prevent service disruption during the complex process of sorting out the financial difficulties that had engulfed public transport in Victoria.

1.6.4 The Interim Operating Agreements

A key conclusion of the Franchise Review Process was that the franchises were fundamentally financially unsustainable and could not be rescued by marginal contractual changes or short term financial fixes. However, the State had no right to unilaterally terminate the franchises. It was faced with a choice of either negotiating with the franchisees to agree new franchise arrangements (particularly in relation to funding levels), or negotiating interim operating agreements which would guarantee the provision of public transport services while it let new train and tram contracts for the medium and long term. The latter would also allow the Government to retain the option of returning the system to public operation if it became clear this option was superior to retendering private sector franchises.

The Government chose to secure the right to hold a competitive retender of the metropolitan franchises and renegotiate the V/Line Passenger franchise with National Express. The Franchise Review Task Force set about negotiating 12-month Interim Operating Agreements (IOAs) with the franchisees around the middle of 2002. At their simplest, the IOAs provided the State with a right to terminate the franchises at a time of its choosing in exchange for the State funding a percentage of the franchisees’ interim operating losses. The Government made a decision at this point that the businesses would be restructured to create a single metropolitan train company and a single tram company in order to improve fleet management, secure economies of scale and reduce the number

Department of Infrastructure 13 and complexity of interfaces in the industry. The IOAs flagged this intention, and guaranteed the franchisees a right to bid for the new train and tram franchises (subject to their not being in breach of their current agreements).

The IOAs set out the operating arrangements that would apply while the businesses were being retendered, and activated the termination provisions of the Franchise Agreement. In particular, the IOAs prevented cuts in maintenance, staffing or services. The franchisees were part-way through the implementation of a range of capital projects, and the IOAs stipulated how such projects were to be handled.

The IOA negotiation process also provided an opportunity to resolve the balance of the outstanding claims and disputes left over from the Settlement Deeds. When the IOAs were signed in December 2002, the franchisees agreed to release the State from all claims. Under the IOAs, the Government provided interim financial support in the form of sharing of operating losses, resulting in payments of $20 million to Yarra Trams and $27 million to Connex over 2003.

1.6.5 National Express withdraw

However, National Express could not reach agreement with the Government on its IOAs and it decided in December 2002 to withdraw from its Victorian rail operations. In withdrawing from its franchises, National Express forfeited Performance Bonds (doubled in value under the terms of the Settlement Deeds), totalling $135 million. Its overall write-offs were more than double this, mainly as a result of having to write off maintenance expenditure which had been capitalised.

National Express’s decision to withdraw parent company support from its three franchises meant that they were insolvent. It gave the Government a week’s notice of its intention. Under the terms of the Franchise Agreement, the Government had a number of options in the event of franchisee default, and it chose to appoint Receivers and Managers to take over operation of the M>Train, M>Tram and V/Line Passenger franchises.

While there was no IOA for M>Train, M>Tram or V/Line, the Government held a charge over the assets of the companies which allowed it to appoint Receivers and Managers to take over the National Express franchises. National Express and the Government agreed arrangements for an orderly handover of the businesses and their operations. At the same time (in the week between National Express’s announcement and departure), the Government moved to protect the entitlements of all employees of the National Express franchises, secured the cooperation of the transport unions, and prepared appropriately accredited managers to assume control of the businesses. In addition, both Yarra Trams and Connex offered high level support, should it be required, to keep services running. In the event, Government control resumed on 23 December 2002 with no adverse impact on passengers whatsoever, an achievement made possible by the work and cooperative effort of players across the industry, including management, union officials and staff within PTD.

So after 18 months of hard work to stabilise the industry, IOAs were now in place with two franchises and short term stability had been brought to the other three with the appointment of Receivers and Managers. The Government was ready to develop a permanent solution to the structural and financial problems in the industry, and determine whether this should be done through reversion to public ownership, an open tender for the businesses or a negotiation with the existing franchisees, Yarra Trams and Connex.

Department of Infrastructure 14 Chapter 2: The Refranchising Process

2.1 Retender, renationalise or renegotiate?

The departure of National Express had significant ramifications for the refranchising process. With IOAs in place with Yarra Trams and Connex the Government was able to proceed with a competitive retender of the businesses, but it was far from clear that this was now the best course of action. The Government was committed to amalgamating the metropolitan businesses to provided one train franchise and one tram franchise (see Section 2.3.1), but with only two incumbents left, their competitive advantage in any retender would be powerful.

The first decision the Government therefore had to make was how to proceed. Given the success of privatisation in delivering improved services to passengers, the Government was not keen to take the whole public transport system back into State operation (although this possibility was not ruled out). This left it with the choice of either retendering or negotiating exclusively with the remaining incumbents.

2.1.1 Competitive retender

A competitive tender had the advantage of being open and transparent, and was particularly attractive given the significantly higher level of funding likely to be required for any new franchise arrangements. A retender would be seen to be impartial and ensure that taxpayers were getting the best possible value for money.

However, there were a number of strong arguments against a retender:

• Potential lack of market interest

The 1999 franchising process attracted strong international interest. Since then, the Victorian franchisees had sustained large financial losses culminating in the withdrawal of National Express. There had also been a substantial downturn in the UK market (the main source of bidders in the original franchising) with many in that market primarily focused on the UK refranchising process. In addition, potential bidders were acutely conscious that they would be bidding against incumbents who were performing well and who had strong local knowledge. As such, it looked unlikely that the Government would be able to attract a strong field of bidders in a retender.

• Further instability in the rail industry

The previous five years had not been conducive to managerial stability in the rail industry. The corporatisation and privatisation of the industry in 1998/99 was followed by a period of acclimatisation as franchisees struggled to get to grips with the new commercial environment, and by the financial pressures which resulted in the withdrawal of National Express. None of this had helped the industry to address the key strategic challenges it faced in areas like ticketing, marketing, revenue protection and asset maintenance. A period of stability and consolidation was therefore highly desirable.

• Risks for new entrants

Any new bidders in the market for Melbourne’s rail franchises would want a high degree of certainty about the commercial and legal environment they were entering. In a number of crucial areas, however, it would not be possible in the short or medium term to offer them the comfort they would require. Issues like asset condition, the new ticketing system, revenue allocation and the introduction of new fleets on to the M>Train, M>Tram and Connex networks created higher apparent risks for new entrants than for incumbents. It might have been necessary for the Government to reduce the transfer of risk to a “lowest common denominator” level in order to attract and maintain the interest of sceptical external bidders.

Department of Infrastructure 15 • Financial impacts

During the IOA negotiations, the Government had carefully scrutinised the franchise businesses and conducted “open book” reviews of their financial performance and forecasts. On the basis of this analysis, it seemed unlikely that retendering would unlock significant financial savings.

• Knowledge of the system

The incumbent franchisees were already familiar with the environment of the Victorian rail industry. Normal commercial practice would be to deal with incumbent suppliers, tapping into their knowledge base, and not seek a change of supplier at a sensitive stage in the development of the public transport system.

This was particularly important given the number of major projects affecting the rail industry over the next few years, including Regional Fast Rail, the Spencer Street Station Redevelopment, the new ticketing system and the Commonwealth Games, all of which created levels of uncertainty that would be difficult for external bidders, with no local knowledge, to appreciate in their bids.

In addition, a competitive tender did not of itself guarantee a good result: the original franchising process had been based on a highly competitive tender process, and had delivered outcomes which were financially unsustainable.

2.1.2 Negotiation with incumbent franchisees

The alternative to retendering was to negotiate with the franchisees – for Yarra Trams to operate a combined tram business, and for Connex to operate a combined metropolitan train business. Negotiations could achieve the Government’s “one train, one tram” objective, retain existing system knowledge and experience, and maintain the stability of the public transport system.

The challenge in renegotiating the franchise contracts with the existing franchisees was the need to demonstrate that any resulting deal constituted good value for money for the State. To ensure that value for money was achieved, the Government would have to develop a set of benchmarks against which the operators’ proposals could be evaluated, which would show whether the franchisees could run the businesses more cost effectively than alternative operators. And, even more importantly, any future negotiations would have to be conducted on an “open book” basis.

Considering the risks and benefits of all options, the Government decided to negotiate with Yarra Trams and Connex over the future operation of the metropolitan train and tram networks, while continuing V/Line Passenger in public sector operation. However, in order to exert some competitive pressure on the franchisees it was decided to retain the options of a competitive retender and public operation as fallbacks if negotiations failed. The IOAs could be extended by the State until the end of 2004, so there was enough time to engage in a negotiation, then go to competitive tender if agreement could not be reached bilaterally.

2.1.3 V/Line Passenger

It was decided to retain V/Line in public operation until the Government’s regional rail projects were completed. These included the Regional Fast Rail projects to , , and the Latrobe Valley, country line re-openings to Ararat, , Leongatha and , and the Spencer Street Station Redevelopment. During their construction phase these projects made it difficult to operate a privatised passenger service with any degree of certainty, and even harder to bid for one.

V/Line Passenger was therefore not part of the Refranchising Process and is not considered further in this document.

Department of Infrastructure 16 2.2 The Government’s refranchising objectives

A Refranchising Team was established within the Department of Infrastructure, comprising staff from PTD, Corporate Finance, and a large number of expert external consultants. The Government set the Refranchising Team a number of objectives for the refranchising of the metropolitan train and tram businesses:

• to establish franchising arrangements which deliver rail services which are safe, clean, punctual and reliable and are supported by convenient intermodal connections and high quality passenger information;

• to encourage and achieve innovation in the delivery of public transport services;

• to establish stable and sustainable relationships with franchisees that offer proven managerial expertise, and are committed to positive action, in key areas such as:

o operational safety;

o innovation;

o technology planning;

o operational planning and management;

o asset maintenance, renewal and improvement;

o marketing;

o project development and implementation;

o financial management;

o ticketing;

o revenue generation and protection; and

o industrial relations;

• to establish franchises which are financially sustainable but which do not earn excessive profits;

• to achieve value for money in the franchise contracts;

• to secure acceptance by the franchisees of institutional reforms, contractual obligations and commercial risks which support the State’s policy objectives for public transport; and

• to complete negotiations with incumbent franchisees by the end of 2003.

The objectives were strongly flavoured by an overall philosophy of “getting the basics right”: providing a high quality, stable public transport system with the fundamentals firmly in place. This was not designed to achieve the Government’s 20/2020 vision2 overnight, but rather to provide a solid foundation from which this target could be tackled when the new ticketing system was in place and the industry had settled down.

Underlying this was the Government’s vision for the public transport system, of which the key elements were:

2 AspartofitsGrowing Victoria Together (Nov 2001) strategic planning publication, the State Government was committed to working towards 20% of all motorised trips in metropolitan Melbourne being on public transport by the year 2020.

Department of Infrastructure 17 • innovation – the Government wished to draw on the experience and expertise of franchisees to deliver innovative, cost effective solutions in areas such as asset management and improvement, service delivery and provision, project development, ticketing systems, passenger information, revenue protection, information technology and marketing;

• integration – the Government attached great importance to the achievement of seamless and integrated service provision to public transport passengers. It expected franchisees to work effectively with each other and with operators in other public transport modes to improve timetable connections between bus, train and tram services. It expected franchisees to take an active role in delivering improvements to the existing ticketing system and supporting the development of new ticketing technology. The Government wished to ensure that Metlink delivered integrated services to the whole public transport industry, and expected franchisees to actively support Metlink in this role. The Government wished to have the improved integration of public transport services reflected in cost-effective and practicable programs, promoted by franchisees, under which consistent approaches to passenger information, signage and customer service across modes, and common vehicle liveries within modes would be established; and

• customer service – the Government expected franchisees to achieve excellence in customer service. It considered it a priority that franchisees took steps, in concert with the Transit Police, to improve passengers' perceptions of their personal security as they used public transport. The Government expected franchisees and Metlink to work together to improve signage and passenger information across the system, including the progressive improvement of network-wide online and call centre information services.

2.3 Foundations of refranchising

The new franchising arrangements were built on a number of key building blocks on which the Government made early policy decisions. These are articulated below.

2.3.1 “One train, one tram”

The desire to amalgamate franchises to create one metropolitan train company and one tram company had been a Government aim for some time.

The rationale behind the original decision to have two train and two tram businesses was to provide scope for a sharper focus on local markets through smaller businesses, and to generate “competition by comparison”, whereby an operator underperforming compared to its neighbour would strive to improve to the industry best standard, perhaps by adopting some of the superior operator’s innovative practices. Two businesses for each mode also spread the risk to the State if one operator got into difficulties.

However, the benefits of two train and two tram companies never really materialised. Instead, splitting the operations for each mode created a multiplicity of problems:

• difficulty in collective decision making with a large number of industry players;

• duplication of management resources and functions;

• contrived and unwieldy arrangements for shared assets (eg, Metrol);

• interoperator disputes, particularly between the train franchises (see Section 1.5.2) – eg, train signal repair procedures, access to the Showgrounds line;

• loss of system capacity through the necessity for two companies (rather than one) to retain adequate vehicle spares during the peaks, and (on the train network) through station platforming rights;

Department of Infrastructure 18 • loss of potential system flexibility, particularly on the tram network – eg, direct services to the sporting precinct from M>Tram routes were no longer possible; and

• multiplication of rolling stock types – not only did each franchisee order its own type of new rolling stock from its own preferred supplier, but rolling stock was refurbished differently on the two networks, rendering the two Comeng fleets incompatible. On the tram network the new low-floor vehicles were of different floor heights, resulting in the creation of two platform heights at stops in Melbourne.

In addition, having a large number of operators multiplied the number of interfaces within an already complex industry. And the system also created confusion for passengers, who saw the Met become the PTC, which became Hillside Trains, Bayside Trains, Yarra Trams and Swanston Trams, then Connex, M>Train and M>Tram over a relatively short space of time.

With this in mind, the Government decided that, in order to simplify the management of the rail industry, improve coordination between services, secure economies of scale and reduce confusion and uncertainty for passengers, it would reduce the number of metropolitan rail franchisees from four to two. Fewer players, less propensity for confusion, more efficient decision making and fewer disputes.

2.3.2 Metlink

The restructuring of the PTC into a number of disparate commercial players had made it harder to manage vital areas like ticketing reform, marketing, passenger information, complaints handling, and to some extent revenue protection. Responsibility for these industry-wide functions was spread across a number of bodies, which was not conducive to coordinated action by operators.

As it approached refranchising, the Government decided to make a significant change to the structure of the rail industry by creating a new company – Metlink – to bring together network-wide functions under a single, focused organisation operating under a direct contract with the State. Metlink would be wholly-owned by the metropolitan franchisees, but provide services to all operators (including V/Line and the Bus Association of Victoria) and to the State under contract.

Metlink was to subsume the functions of the:

• Revenue Clearing House (RCH) – revenue allocation and day-to-day management of the automatic ticketing system;

• VicTrip – customer information, website, call centre and the Metlink Shop; and

• Melbourne Passenger Growth Initiative (MPGI) – the franchisees’ collective marketing company.

Metlink would bring these functions together, exploiting the obvious links between them and (through its direct contract with the State) recognising the Government’s long term interest in their effective management, including marketing and customer information, policy and advocacy, and ticketing and revenue protection.

A more detailed discussion of Metlink and its activities is provided in Sections 3.3 and 4.10.

2.3.3 Contract length

Long contracts, such as the 12-15 year metropolitan train and tram contracts let in 1999, can offer good value where the private sector is expected to finance and amortise major up-front capital investments. However, long term contracts may also present high risks for private sector operators, exposing them to uncertainties, such as macroeconomic conditions, which they do not control. In the case of the rail franchises, the likely introduction of a new ticketing system in 2007/08 presented added complications, making it hard to forecast revenue trends beyond a five or six year horizon. The possibility of a revenue shock as the new technology and new fares structures kicked in made the revenue environment after 2007 impossible to forecast with any confidence.

Department of Infrastructure 19 For these reasons, the Government decided that the new franchise contracts for the train and tram businesses would run until the end of November 2008. This would take the franchises to the end of the introduction of the new ticketing system. However, in case the system took longer to implement (and to provide procurement flexibility), the Government asked the franchisees to provide a separate price in their Offers for the period up until the end of May 2010. The new arrangements would allow the State (at its sole discretion) to exercise an option to extend the new franchises for between six and 18 months on the pre-agreed terms.

In addition to this, it was decided that the new contracts would also provide an opportunity for the State and the franchisees to enter into “without commitment” discussions on the possibility of a negotiated extension of the franchise contracts (or their replacement by entirely new contracts) beyond May 2010. The Government included in the Franchise Agreement a number of performance-based criteria it would take into consideration in determining whether it wished to enter into such negotiations towards the end of the new franchise period.

The shorter contract length was less risky for the franchisees but had implications for a range of other elements of contract design and the new franchises (eg, the infrastructure maintenance and renewal regime).

2.3.4 Asset sale

With State-appointed Receivers and Managers operating the M>Train and M>Tram franchises (and V/Line Passenger), it was necessary to decide how these businesses would be transferred to the new operators (Connex and Yarra Trams). There were two possible options: a share sale, where the businesses were sold to the new operators in their entirety, or an asset sale, where the key assets, personnel and contracts of the M>businesses were transferred (leaving liabilities behind).

In choosing between an asset or a share sale, a number of issues needed to be considered, the most significant of which were:

• Residual liabilities and State indemnities

A Deed of Company Arrangement (DOCA) was entered into to deal with most claims from creditors of the M>Train and M>Tram companies. However, the DOCA did not necessarily extinguish all liabilities of the M>businesses. The types of liabilities that might not be extinguished by the DOCA included breaches of non-monetary obligations, claims arising after the companies went into Receivership, and certain tax and public liability claims. It was therefore desirable to ensure the State and the new franchisee were not exposed to uncapped liabilities, while still providing the State with flexibility to intervene in special circumstances (eg, a personal injury claim against an insolvent M>business).

Under a share sale, liabilities simply passed to the purchaser. However, an asset sale allowed for the vendor and purchaser to agree on which liabilities would be assumed by the purchaser and which would remain with the vendor, thereby providing greater flexibility so as to ensure that Yarra Trams and Connex would not be required to assume unnecessary or inappropriate risks. This would then allow the State to deal with residual liabilities remaining in the M>businesses as it saw fit.

• Transaction costs and timing

The Government wanted to ensure that transaction complexity did not delay the Refranchising Process, and to minimise the financial cost of the transaction.

An asset sale would require all employees and contractors to be individually managed at the time of sale (between contract Execution and Completion), but would not necessitate any indemnities from the State. A share sale marginally simplified the process of transferring employees and contracts, but due diligence would be significantly more complex and lengthy and the State would come under pressure to provide the new franchisee with indemnities for any liabilities associated with the M>businesses.

Department of Infrastructure 20 • Thiess and Bombardier contracts

Under the original franchising arrangements, M>Train sub-contracted infrastructure maintenance activities to Thiess Infraco, and M>Tram contracted infrastructure maintenance to Thiess and rolling stock maintenance (for existing vehicles) to Bombardier. These arrangements suited the National Express business model but were different from the arrangements put in place by Yarra Trams and Connex.

Under a share sale, the flexibility for Yarra Trams and Connex to manage important parts of their franchises (rolling stock and infrastructure maintenance) in their preferred ways would be lost because these sub-contracts would automatically transfer to the new businesses. An asset sale would allow Yarra Trams and Connex to adopt any business model (including continuing to deal with the incumbent suppliers).

• Bidder preference

Both Yarra Trams and Connex indicated a preference for an asset sale.

In light of the reduced risk and greater flexibility it offered, and the franchisees’ preference for it, an asset sale was the approach to transfer selected by the Government.

2.3.5 Managing risk

The original franchising arrangements were characterised by an unsustainable transfer of risk to the franchisees. In the new contracts the Government aimed to provide a more balanced sharing of risk and reward.

The guiding philosophy behind Partnerships Victoria3 is that risk in public-private partnerships should generally be allocated to the party best able to manage it. In the case of public transport, neither the State nor the franchisees were uniquely able to manage farebox revenue risk. A sharing of the risk was likely to present the most cost-effective solution for both parties.

With this in mind, the Government designed a farebox revenue risk-sharing mechanism, where it would make up some of the shortfall in the event that farebox revenue fell below a threshold level, thereby providing a level of “downside” revenue protection to the franchisees. The risk-sharing mechanism is examined in more detail in Section 4.3.1.

The risks on the cost side of the franchise businesses were more readily manageable by franchisees than those on the revenue side. The key costs in the franchise businesses were labour, maintenance (which itself included a strong element of labour), rolling stock lease payments, capital investment delivery, traction power and corporate overheads. There was no obvious reason why the State would be better placed to control these risks than franchisees, or why it would wish to take them on. It was therefore decided that franchisees should continue to manage most cost-side risks.

Conversely, the Government believed that it would be unacceptable for franchisees to earn excessive returns from the operation of publicly owned public transport assets, particularly in the circumstances of single-source negotiations where the State was sharing a significant part of revenue downside risk. It was therefore decided to include a profit-sharing mechanism in the Partnership Agreements to enable the State to share in the benefits if a franchisee’s financial performance turned out to be much better than expected. It was important to retain an incentive for the franchisees to grow revenue and operate efficiently, and so the profit sharing mechanism was not designed to kick in until substantial excess profits were being generated. This is discussed in more detail in Section 4.3.2.

A summary of all key risks and their allocation is provided as Appendix 2 to this document.

3 A State Government policy released in June 2000 governing how infrastructure projects should be delivered in public- private partnerships.

Department of Infrastructure 21 2.3.6 Vertical integration and asset maintenance

Vertical integration of the franchise businesses had worked well and the Government supported its retention in the new contracts. However, the performance-based regime for measuring the condition of infrastructure was not a success, and this was scrapped in preference for a new input-based regime. The new regime is described in Section 4.4.1.

2.3.7 Revenue allocation

The revenue disputes which characterised the original franchising arrangements (see Section 1.5.2) had been a major headache not only for the franchisees, but also for the Government, which was keen to avoid similar problems in the future. Instead of variable quarterly farebox revenue allocation to operators based on a survey of ticket usage by mode, the Government fixed the allocation in the new arrangements at:

• Train – 40% (down from around 58% under the old arrangements);

• Tram – 40% (up from around 28%); and

• the State (on behalf of bus) – 20% (up from around 14%).

The effect of this was to:

• reduce the volatility in each operator’s revenue – by removing the variability resulting from short term changes in ticket usage on one mode versus another mode, and from survey measurement of usage;

• slightly reduce the overall risk to the franchisees – total franchisee exposure to farebox revenue risk was reduced from around 86% under the original arrangements to 80% under the new;

• significantly reduce the farebox revenue risk to the train operator – this was in line with Connex’s preference not to take on a large amount of revenue risk;

• significantly increase the farebox revenue risk to the tram operator – this was designed to give the tram franchisee more incentive to reduce fare evasion (as trams have much higher fare evasion rates than trains), and was in line with Yarra Trams’ willingness to take on a larger amount of revenue risk; and

• make a revenue impact on any part of the metropolitan public transport system an impact on all of it – meaning that anything that increased or reduced farebox revenue on, say, trams would also increase or reduce revenue on trains (and buses). The fixing of revenue shares effectively joined the franchisees at the hip and focused them on working together to grow the total revenue pool.

2.4 Structure of the Refranchising Process

The Government made a decision to negotiate with incumbent franchisees in April 2003. The process was designed to be iterative, so that the State could provide feedback on franchisees’ initial proposals and allow the franchisees to revise their proposals in the light of the feedback received.

At the same time, the negotiations with Connex and Yarra Trams needed to be highly structured, with formal protocols governing the flow of information to and from the franchisees and a clear process for initiating and concluding negotiations. The key reasons for favouring a structured approach were:

• the need for the State to conduct its own “due diligence” on the franchise businesses before negotiations commenced, to ensure that information provided to franchisees by the State was complete and accurate (reducing the risk of subsequent disputes and claims)

Department of Infrastructure 22 and to ensure that the State was armed with the information (including financial benchmarks) it needed in order to negotiate effectively with franchisees;

• the need to keep a clear record of the data supplied to the incumbent franchisees so that, if negotiations were unsuccessful and a competitive retender was initiated, the State could ensure that, as far as possible, new bidders were on a “level playing field” with incumbents;

• the need to fulfil probity and audit requirements and satisfy the Probity Auditor and the Auditor-General that the State had followed a rigorous, objective and defensible process in its dealings with the two franchisees; and

• the need to avoid any claims by franchisees if negotiations were unsuccessful that they had not been treated fairly or given a reasonable opportunity to “bid” for the franchises.

A formal Committee structure was established to oversee the conduct of the negotiations. Cabinet would take final decisions on the outcome of negotiations. An inter-departmental Reference Committee (chaired by the Secretary of the Department of Infrastructure, with senior representatives of the Department of Treasury and Finance and the Department of Premier and Cabinet) was established to oversee the negotiating process and to approve all key documents. Face-to-face negotiations and the evaluation of franchisees’ Offers for the combined businesses were undertaken by dedicated transaction teams. The teams reported into a Project Oversight and Evaluation Committee chaired by the Director of Public Transport.

This structure is represented below.

Cabinet

Passenger Rail Franchising Reference Committee NB: The Reference Secretary DOI Committee’s role and Deputy Secretary DTF responsibilities changed after Deputy Secretary DPC negotiations with franchisees Director of Public Transport commenced Executive Director of Corporate Resources DOI

Passenger Rail Franchising Project Oversight & Evaluation Committee Director of Public Transport Transaction Team leaders PTD representatives DOI Corporate Services DTF, DPC

Technical & engineering advice

Financial & tax advice

Legal advice Train Tram Transaction Team Transaction Team Safety advice

Operations & rolling stock advice

Policy

Department of Infrastructure 23 The process proceeded as shown below.

Phase 1: High level framework for Refranchising Process: Process and accountability April 2003 Objectives Timelines & Resource Plan

Phase 2: Tender Development phase: Preparation of key Tender Documents, including RFP Quality assurance on data Population & cataloguing of Data Room April – August 2003 Contract design Probity Plan & briefings Financial benchmarks completed

Commencement of negotiations: Issue of key tender documents to franchisees: August 2003 RFP, DRG, CDG, Infrastructure Guidance Data Rooms open

Phase 3: Offer preparation phase: Question & answer process Site visits August - November 2003 Consultation on draft Transaction Documents (contracts) Final Transaction Documents issued

Final Offers submitted November 2003

Phase 4: Evaluation of Final Offers November – December 2003

Phase 5: Recommendations & Decisions December 2003 (tram) Advice to Cabinet, supported by Offer evaluation reports February 2004 (train)

Phase 6: Contractual Close February – April 2004 Transition & Handover

At any stage of the process, the Government or a franchisee could terminate negotiations if it became apparent that no deal was likely to be forthcoming.

Phase 1 has already been discussed above. The processes involved in the remaining phases are described in the rest of this chapter.

2.6 Documents provided to franchisees

Before negotiations commenced, a number of key documents were released to the franchisees:

2.6.1 Request for Proposal

The Request for Proposal (RFP) was an invitation to the franchisees to make Offers for the combined train and tram businesses. It set out:

• the terms and conditions governing the Offer process;

• the Government’s objectives for the passenger rail industry in Victoria and the Refranchising Process;

Department of Infrastructure 24 • the structure of the negotiating process;

• the documents and data the franchisees were required to submit in support of their Offers;

• the evaluation criteria that the State would use in evaluating the Offers;

• the transition and completion arrangements for the new combined businesses; and

• requirements on the handling of Offer documents and other confidential data.

The RFP also provided details on how final Offers were to be submitted. The RFP was the “guts” of the tender offer, but it was supported by a number of other essential documents.

2.6.2 Data Room Guide

The Data Room Guide (DRG) assisted franchisees in using the Data Rooms (see Section 2.8.3). It provided information on the processes of information dissemination and the rules and protocols of the Data Rooms, the question and answer process, and access to M>business staff.

A Communications Plan was also produced to support the process and establish appropriate principles of interaction between all parties involved in the Refranchising Process.

2.6.3 Contract Design Guide

The Contract Design Guide (CDG) summarised the Government’s intentions for the design of the key franchise documents (primarily the Franchise Agreement, the Infrastructure Lease and the Metlink Services Agreement). It was mainly concerned with changes to the existing franchise arrangements and was the result of an extensive program of analysis and policy development work by the Government over the previous year.

A consultation draft of the CDG was provided to franchisees in May 2003 to gauge initial reaction to the changes the Government proposed to make. The franchisees were generally positive towards the proposals, but did provide feedback in a number of areas which the Government incorporated into the final document released with the RFP. The CDG was merely a foundation, and the policy principles it contained were developed in much more detail in the Partnership Agreements subsequently executed between the State and franchisees.

2.6.4 Asset Management Plan Guidance Material

With the move from an output-based infrastructure maintenance and renewal regime to a more input-based regime, the franchisees’ Asset Management Plans took on much greater importance (see Section 4.4.1). The Government was keen to communicate to franchisees its vision for the long term maintenance and renewal of the train and tram infrastructure, to require that the activities of the franchisees were consistent with this vision, and to ensure that the asset management regime was practical, cost effective and objectively measurable.

With this in mind, and to provide a clear explanation of its expectations regarding the new regime, the Government provided franchisees with an Asset Management Plan Guidance Material document. This provided a framework and supporting information to assist the franchisees in the preparation of their Asset Management Plans and Annual Works Plans. The document was initially provided to the franchisees as a consultation draft in July 2003. Their feedback was taken into account in the revised guidance material issued in August 2003.

2.6.5 Infrastructure Improvements Regime

As part of the new infrastructure maintenance and renewal regime, the franchisees were provided with a consultation draft on the proposed infrastructure improvements regime (this is explained in Section 4.4.2). This document was never released in a “final” form – the draft version provided the franchisees with all the information they needed, and after discussions with the Government the franchisees provided Asset Improvement Project lists with their final Offers.

Department of Infrastructure 25 2.6.6 Initial Offer Template

The Initial Offer Template (IOT) was a detailed template prescribing all the financial information which the franchisees had to submit in support of their Offers for the combined train and tram businesses. Instructions were included with the IOT outlining the purpose and structure of each section and detailing how it was to be filled in.

2.7 Public Sector Benchmark

2.7.1 Rationale and purpose

A critical objective for the Government, having decided to negotiate with the incumbent franchisees rather than undertake a competitive retender of the franchise businesses, was to achieve and demonstrate value for money. The Public Sector Benchmark (PSB) estimated, on a risk-adjusted basis, the likely cost to the State of operating the franchises efficiently in the public sector. This was not only important in ensuring the franchisees’ Offers were reasonable, it was also an integral part of the negotiating process, helping to keep the franchisees “honest” during discussions.

In many ways, the PSB was similar to the Public Sector Comparators prepared for Partnerships Victoria projects. Both involved the production of financial forecasts (costs and revenues) over the life of the proposed contract, and the adjustment of those financial forecasts to allow for risk. However, there were also significant differences between the PSB used for the Refranchising Process and conventional Public Sector Comparators.

A key role of Public Sector Comparators in Partnerships Victoria projects is to identify the likely cost of a project. The Government will not generally commit to providing a piece of infrastructure until a Public Sector Comparator has been prepared, and the risk-adjusted costs of the project have been compared to its estimated benefits. The circumstances of the public transport industry were rather different, in that the infrastructure and associated services already existed and were being operated in the private sector. There was no question as to whether the Government would support the continued operation of the train and tram systems. The only question was how – and that was not wholly or primarily a financial question. The Government’s objectives for franchising were as much about quality of service, managerial capability and the need for stability in the rail industry as they were about cost. In assessing whether franchisees’ proposals adequately met the Government’s objectives, a financial benchmark would only ever provide part of the answer.

The preparation of the PSB required the Government to make assumptions about the behaviour over the long term of businesses operated in the public sector. Partly for this reason, the choice between public sector operation and private sector franchising was best taken not on the basis of a predefined “black box” decision based on a Public Sector Comparator or financial benchmark, but rather on the basis of a wider set of policy considerations in which the benchmark was an important but not decisive analytical tool. The PSB was therefore used to assist in the evaluation of Offers, but did not in itself determine the outcome (ie, it was not a “hurdle requirement”).

The PSB was at least as important in informing ongoing negotiations with franchisees as in the decision-making phase that followed the completion of those negotiations. As franchisees prepared and submitted proposals, the Refranchising Team was able to identify aspects of the proposals which, on the face of it, were either excessively conservative or excessively ambitious.

The preparation of the PSB enabled the Government to:

• assess the extent to which franchisees’ proposals reflected best achievable practice in revenue generation and cost efficiency;

• assess the financial sustainability of franchisees’ proposals;

• identify any areas in which the franchisees may have made errors or mispriced risks; and

• identify the likely impact on the State’s Budget of restoring the metropolitan rail businesses to financial viability.

Department of Infrastructure 26 2.7.2 Process of developing the PSB

The PSB measured the cost of providing the franchise services, including infrastructure maintenance and renewal, Metlink and the new initiatives contained in the Contract Design Guide, for an efficient public sector organisation. The scope of work for the PSB included:

• gaining an understanding of the proposed franchise arrangements;

• identifying existing major revenue and cost categories and assessing the current state of operations, management and business issues for each;

• constructing a reference project based on the most effective mode of public sector operation. In particular, it was important to consider whether certain cost items, such as rolling stock and infrastructure maintenance, were to be performed in-house or contracted to third parties;

• gaining an understanding of any matter which was likely to affect each of the revenue and cost categories over the franchise period as well as any factors likely to impact on competitive neutrality;

• undertaking historical analytical work to gain an understanding of the nature/behaviour of costs and to assist in formulating a base from which to develop a forecast;

• based on all the analytical and exploratory work of business issues, revenue and cost behaviour, formulating key risks and setting probability distribution boundaries for potential outcomes;

• identifying synergies that could arise from the combination of the two tram and train businesses;

• identifying transition costs which would be incurred in merging the two tram and train businesses;

• identifying and quantifying retained and transferred risk and undertaking risk workshops involving key public sector stakeholders;

• modelling the raw PSB and the value at risk to be transferred; and

• preparing a PSB report, including scope of work, key findings, assumptions on which the PSB was based, and matters outstanding or to which the PSB would be subject (eg, material errors, revision to service levels, quality standards, etc).

Data for the PSB was drawn from a wide variety of sources. External consultants assisted with the assessment and assumptions of farebox revenue, infrastructure costs, rolling stock maintenance costs and operational cost efficiencies. Other data came from the Government’s due diligence of the franchises (Connex, Yarra Trams and the M>businesses), historical data and Business Plan reviews.

It was recognised that the PSB would play an important role and would be subject to a high level of scrutiny. Accordingly, emphasis was placed on documenting the basis upon which assumptions were made. Wherever possible, historical analysis was used to support PSB assumptions. Where this was not possible, the lack of reliable data was noted, and reflected in the risk calculation.

All data was subject to rigorous and exhaustive interrogation in order to validate it. In addition, data, assumptions and risks were reviewed as part of the risk workshops conducted with PTD specialists.

The data provided a “Raw PSB” based on a point estimate of costs – ie, the single, “most likely” cost figure for each line item. This was then subject to a risk assessment process where risk profiles were developed for cost and revenue categories. These provided a range of possible values on which an average could be calculated. The difference between the “most likely” and the “expected”

Department of Infrastructure 27 (ie, average) values provided an estimate of the value of risk, which was used to calculate the risk- adjusted PSB.

Information collection and modelling

Farebox

M>Train/ M>Tram Risk Quality adjustments Quality Connex/ Risk-adjusted Yarra Trams assurance Raw PSB assurance PSB (Train/Tram) & & (Train/Tram) Metlink review review

Synergies

Transition

2.7.3 Changes to the PSB

To preserve the integrity of the PSB, it was “locked down” in August 2003 before the receipt of draft Offers. To the extent that any matters were outstanding at the time the PSB was locked down, the PSB documentation clearly stated that the PSB was subject to the resolution of certain matters.

Changes to the PSB were only permitted after approval of the Benchmarking and Modelling Committee. Changes were made in circumstances where an error was discovered in the PSB, or where the scope of the proposition had changed. However, where a franchisee included one of its own initiatives in its Offer, this was excluded from the PSB (together with any consequent revenue or cost impacts) and the extra value provided by the franchisee initiative was compared to its expected cost.

2.8 Probity and information gathering

2.8.1 Probity Plan

In any negotiation of this type, maintaining the highest standards of probity is obviously of paramount importance. This was particularly true in the case of the Refranchising Process, where the Government needed to ensure that probity standards were sufficient to protect all parties in the event of a competitive tender (if negotiations failed). The negotiating process was therefore managed with a greater focus on formal process and documentation than would usually occur for a bilateral commercial negotiation. In addition, because of the commercial nature of the negotiations, much of the documentation relating to the process was highly confidential, requiring tight controls on its dissemination.

The Government produced a Probity Plan in May 2003 which put in place processes to ensure that the integrity of the Refranchising Process was maintained and attempted to ensure that in the event of a retender of the metropolitan rail businesses all participants could be treated fairly and equitably, and compete from as level a playing field as possible.

The probity objectives for the Refranchising Process were to ensure that:

• the process was fair, unbiased and impartial at each stage;

• franchisees’ Offers were assessed objectively and consistently in accordance with specified evaluation criteria;

Department of Infrastructure 28 • the process was transparent;

• conflicts of interest, whether perceived, actual or potential, were avoided and, where they arose, identified and eliminated;

• in the event that negotiations with Yarra Trams and/or Connex were unsuccessful, a defensible, transparent and equitable competitive tender process for the metropolitan rail franchises could be run without putting external bidders at an unreasonable disadvantage compared to incumbents; and

• the confidentiality of information was maintained.

In order to maintain high standards of probity throughout the Refranchising Process, an independent Probity Auditor was employed to oversee the process and sign off at each stage. The Victorian Auditor General’s Office was also briefed regularly on progress. The measures taken to ensure that probity objectives were met were broadly related to contact between the franchisees and the Government, contact between the franchisees and the M>businesses, and the Government’s internal processes.

2.8.2 Contact between the franchisees and Government employees

To maintain probity standards it was desirable for negotiations between the franchisees and the Government to be quarantined from the day-to-day process of contract management. Public Transport Division (PTD) was responsible for managing contracts and wider relationships with Yarra Trams and Connex on behalf of the Government, and staff in PTD continued to be responsible for managing these ongoing relationships while the Refranchising Process was implemented.

During the Refranchising Process, the franchisees needed to receive consistent and clear communication as to the basis on which their Offers were to be invited and evaluated. Given the extensive and often informal interaction between PTD staff and Yarra Trams and Connex required for ongoing franchise management, it was important that this did not create a situation in which the franchisees were given information which was at odds with the terms or intent of the RFP or the Refranchising Process.

To ensure the separation of negotiation and franchise management, only specific, named individuals were authorised to discuss the negotiating process with franchisees (or their advisers or key suppliers). Where a PTD employee had day-to-day dealings with franchisees but was also an authorised person, they were required to identify to franchisees whenever they were speaking in an authorised capacity. This ensured that franchisees did not receive misleading or conflicting messages from the Government as a result of an inadvertent or ill-informed comment by a public servant who was not involved closely with the Refranchising Process.

All PTD employees were advised of these arrangements and informed not to speak to franchisees about any aspect of the Refranchising Process if they were not authorised.

2.8.3 Contact between the franchisees and M>business employees

There was no restriction on contact, dialogue and joint working between Yarra Trams and Connex during the Refranchising Process, and in fact it was considered that the Government’s objectives for refranchising were more likely to be met if Yarra Trams and Connex cooperated with each other constructively before, during and after the process.

However, franchisee contact with the M>businesses was another matter. The Government needed to ensure that if negotiations with Yarra Trams and/or Connex failed, it could retender the franchises and minimise the disadvantage to incoming bidders. This objective was unlikely to be achieved if the incumbent franchisees were getting large amounts of information and advice informally from their counterparts at the M>businesses.

On the other hand, it was essential that the franchisees had as much information as possible about the businesses for which they were to make Offers. Any gaps in their knowledge represented risk to the franchisees, which would be passed on as an increased funding requirement to the Government.

Department of Infrastructure 29 The solution was to allow franchisees to question and meet with M>Train and M>Tram staff, but within a highly structured environment and with strict protocols in place. Data Rooms were set up to provide information to the franchisees (an M>Train Data Room for Connex, and an M>Tram Data Room for Yarra Trams). A lengthy and exhaustive due diligence process was undertaken by the Government working together with the M>businesses to populate the Data Rooms with information necessary to the franchisees’ Offers. The Data Rooms were an information resource (comprising around 8,000 documents), which could be provided to new bidders in the event of a retender with confidence that those bidders would have access to the same M>business data as the incumbent franchisees.

As part of its due diligence process, the Government also collected extensive data from Yarra Trams and Connex. If a retender was necessary this data could be accessed by all bidders.

When a franchisee needed clarification or further information from an M>businesses, it could:

• ask a question via the Data Room – this was a formal process identical to that used in a standard tender, whereby the franchisee filled in a question form and submitted this via their Data Room coordinator. The coordinator then assigned the question to the relevant M>business person, who completed a reply and sent it back to the franchisee, once approved, via the coordinator; or

• request a meeting with M>business staff – meeting requests also went through the Data Room coordinator. Franchisees were likely to request meetings for site visits to infrastructure (eg, to check depots or track condition) or where an issue was complex and required face-to-face discussion (eg, human relations issues, driver training system). All meetings required an authorised person from the Government to be present, who recorded the discussion by annotating an agenda. This meant that in the event of a retender new bidders could be brought up to speed with discussions that franchisees had had with the M>businesses.

In addition to the Data Room Guide, franchisees were provided with a Communications Plan detailing these arrangements and making it clear that any breach of probity standards would be treated very seriously. Franchisees executed stringent confidentiality agreements protecting the data provided to them during the course of the Refranchising Process. In addition, they were required to confirm in writing to the Probity Auditor at key stages of the Refranchising Process that they had not breached probity standards.

2.8.4 Internal Government processes

In addition to supporting the processes outlined above, the Government put in place a number of other measures designed to ensure probity standards were maintained:

• secure areas were set up to store both hard copies and electronic copies of documentation relating to the Refranchising Process;

• the Refranchising Team (including advisors) was physically separated from the rest of PTD and accommodated in a secure area;

• Refranchising Team and PTD staff were prohibited from accepting hospitality from franchisees;

• all authorised staff were required to sign confidentiality deeds and provide assurances that they had no conflicts of interest; and

• the Reference Committee was separated from the role of evaluation. The Reference Committee was responsible for overseeing the management of the Refranchising Process, considering and approving key documents, and for management of the Refranchising Team’s access to Cabinet. However, the Reference Committee played no part in evaluating Offers from franchisees, beyond noting the evaluation reports. This ensured the evaluation was not influenced by people who hadn’t read the Offer documents and considered them in line with the requirements of the RFP.

Department of Infrastructure 30 2.9 Negotiation

After the franchisees submitted their Initial Offer Templates and other Offer documents (eg, Business Plans) in September 2003, negotiations began in earnest between the franchisees and the Government. Negotiations were concerned with the price offered by the franchisees (ie, the annual funding requirement), the scope of services and infrastructure works (particularly for train), and the detail of the franchise contracts.

2.10 Evaluation of Offers

Final Offers were received from franchisees on 17 November 2003 and, though subject to resolution of a number of issues, were effectively binding on franchisees.

2.10.1 Evaluation criteria

Ten criteria, documented in the RFP before the Refranchising Process commenced, were used to evaluate the Offers.

• the extent to which the franchisee’s proposals to improve service quality would encourage growth in public transport patronage;

• the quality of the franchisee’s proposals for asset management;

• the quality of the franchisee’s proposals in other areas;

• the willingness and ability of the franchisee to improve public transport ticketing;

• the financial sustainability of the franchisee’s proposals;

• the cost to the State of the franchisee’s proposals;

• the extent to which the franchisee accepted the State’s contractual requirements;

• the extent to which the franchisee imposed conditions on its Offer;

• the managerial capability and relevant experience of the franchisee; and

• the quality of the documents submitted by the franchisee in support of its Offer.

The critical decision for the Government which would determine the outcome of the negotiations was whether each franchisee’s Offer provided better outcomes, when measured against the evaluation criteria, than the Government could obtain on an equivalent basis from either:

• an open competitive tender of the existing franchises, either on a stand-alone basis or as part of a combined train or tram business; or

• the operation of the metropolitan train/tram business and the functions ascribed to Metlink in the public sector.

2.10.2 Evaluation process

The decision-making structure is represented overleaf.

Department of Infrastructure 31 Passenger Rail Franchising Cabinet Reference Committee

Quality-based review of presentation of data and recommendations to Ministers, Passenger Rail Franchising Direction of Cabinet agenda and coordination Project Oversight & Evaluation Committee of Departmental briefings

Review of evaluation reports and confirmation of their completeness, relevance, accuracy and compliance with the RFP. High level project management review.

Transaction Team – Train Transaction Team – Tram

Preparation of full evaluation reports, drawing on input Preparation of full evaluation reports, drawing on input from specialist evaluation teams and relevant financial from specialist evaluation teams and relevant financial benchmarks. benchmarks. Preparation of draft recommendations to Ministers. Preparation of draft recommendations to Ministers. Securing sign off from Probity Auditor on compliance of Securing sign off from Probity Auditor on compliance of evaluation process with RFP, Probity Plan and other evaluation process with RFP, Probity Plan and other relevant requirements relevant requirements

Financial Patronage & Legal Advisory Quality & Asset Advisory Advisory Team Operations Team Capability Team Team Advisory Team Comparison of Offers Advice on conformity Assessment of the Advice on the to benchmarks, Advice on future of franchisees’ Offers managerial capability maintenance, renewal assessment of demand, OPR, with Transaction and service quality and improvement of consistency and timetable, capacity Documents and tender demonstrated in each franchise assets accuracy of data, and fleet availability documents Offer; quality of financial sustainability Transition Plans and tax

A number of expert advisory teams were set up to evaluate the franchisees’ Offers and advise the Transaction Teams. The Transaction Teams considered the Offers in their entirety and assessed them against the evaluation criteria. The PSB was also used to test the financial aspects of the Offers.

2.10.3 Acceptance and Execution

The original timeline for the Refranchising Process aimed for completion by Christmas 2003. Yarra Trams’ Offer was accepted in late December, but the Train Transaction Team recommended that further work be done on the Connex Offer before it could be accepted as there were some significant outstanding issues and the price was still higher than was desirable. Negotiations continued with Connex throughout January 2004, while details of the Partnership Agreements were finalised with Yarra Trams. In February, following substantial amendments to Connex’s Offer, it was recommended that its Offer also be accepted.

Formal, fully documented evaluation reports were prepared by the Transaction Teams, providing detailed evaluation of the franchisees’ Offers against each of the evaluation criteria. The recommendation of both Transaction Teams in respect of the Offers from Yarra Trams and Connex was: When measured against the Evaluation Criteria as a whole, having regard to the documents and data submitted by Yarra/Connex and the available factual data about the past performance and future options for operating the metropolitan tram/train business, the Offer submitted by Yarra Trams/Connex fulfils the State’s objectives and vision at least as well as the alternatives available to the State.

The Project Oversight and Evaluation Committee then approved the evaluation reports. A submission recording the outcome of the evaluation process went to Cabinet for approval, via the Reference Committee. Cabinet approved the Yarra Trams Offer (subject to agreeing documentation) in December, and approved the Connex Offer on similar terms in February, following further advice on Connex’s revised Offer.

Department of Infrastructure 32 The Government and the franchisees signed the new contracts on 19 February 2004, and the Premier and the Minister for Transport announced the deal to the media that morning.

2.10.4 Side letters

While the signing of Partnership Agreements occurred on 19 February, a number of issues were still outstanding, particularly in relation to plans that franchisees were required to provide to the State. Remaining issues for resolution were written up as side letters, signed by the franchisees or the Director of Public Transport, as appropriate. The majority of these outstanding issues were cleared up during the transition period between Execution and Completion.

Department of Infrastructure 33 Department of Infrastructure 34 Chapter 3: The Outcome

On 18 April 2004 Connex took over operation of Melbourne’s entire train network and Yarra Trams took control of the world’s third-largest tram network. On the same day, Metlink came into existence and took responsibility for managing the network-wide aspects of the public transport system.

The two franchisees adopted very different structures in order to provide the range of skills necessary to operate the vertically integrated rail businesses. In both cases the franchise business was wholly or partly owned by an international passenger rail operator.

3.1 Yarra Trams’ franchise structure

Yarra Trams retained the same franchise structure under the new arrangements that it had used under the original franchise; it simply added the assets and personnel of the M>Tram business into its existing corporate structure.

Transfield Transdev SA Services Ltd

100%

Transdev Secondment of 100% Australia Pty Ltd Senior Executives 100% Transfield Transdev MetroLink Victoria Pty Ltd 50% 50% Pty Ltd

Alstom NRS Fleet NRS Fleet Yarra Trams Siemrail Vic Australia Ltd Maintenance Maintenance Agreement Partnership Agreement 100%

Nominee Siemens Ltd

Franchise Entity Ownership Franchise Agreement & MetroLink State Infrastructure Lease Contractual Relationship Victoria Pty Ltd (Director)

MetroLink (the nominee name for the Yarra Trams Partnership) is jointly owned by French-owned tram operator Transdev and Australian engineering service providers Transfield. Yarra Trams handles all operations, infrastructure maintenance and existing rolling stock (ERS) maintenance in- house.

New rolling stock (NRS) is maintained by Alstom (Citadis vehicles) and Siemens (Combino vehicles). The Siemens NRS maintenance contract was novated from M>Tram to Yarra Trams. Fifteen-year NRS maintenance agreements were signed with the NRS suppliers when orders were placed for the new vehicles, and as a result it would have been difficult (and of no value) to terminate these maintenance agreements.

More detail on arrangements for supply and maintenance of rolling stock is provided in Section 4.5.

Department of Infrastructure 35 3.2 Connex’s franchise structure4

3.2.1 Basic structure and rationale

The franchise structure adopted by Connex is significantly more complex than that of Yarra Trams. Connex entered into a joint venture with Alstom which allowed Connex to focus on delivering passenger services while effectively outsourcing its infrastructure and rolling stock maintenance obligations.

Under the original franchise arrangements, Connex contracted maintenance of infrastructure and rolling stock to Alstom through a single homogeneous contract (the “AMPA”). Although the AMPA transferred a large measure of risk to Alstom, this simple “purchaser/supplier” arrangement led to difficulties when Connex sought changes to the maintenance arrangements, as the AMPA provided little flexibility to alter scope or specifications. This created a disconnection between operations and maintenance that prevented Connex adapting maintenance to improve operational performance and led to conflict between Connex and Alstom.

Connex sought to address these problems by renegotiating its arrangements with Alstom, in particular through the creation of a new joint venture company, MainCo. Connex’s choice of Alstom for its maintenance partner was influenced by its desire to employ a company which could manage both infrastructure maintenance and rolling stock maintenance, thereby reducing interfaces and the propensity for disputes if problems arose. Alstom was the only company with a presence in Melbourne which had experience in both.

Connex’s structure is represented on the next page, followed by a detailed explanation of its operation.

4 More detail on the Connex franchise structure can be found in the Guide to Connex Franchise Structure, DOI, June 2004.

Department of Infrastructure 36 Veolia Environnement SA 100%

CGEA Alstom SA Connex SA

100% 100%

Connex Group State Alstom Australia Pty Ltd (Director) Holdings SA

Franchise Agreement & Infrastructure Lease 100% 100% MainCo Shareholders Connex Agreement Alstom Australia Melbourne Ltd Secondment of Pty Ltd Senior Executives 30% 70%

MainCo MainCo Maintenance Melbourne 100% Agreement Pty Ltd

ERS Maintenance Sub-contract AMTL

Separate Maintenance Agreement (Alstom NRS) Contract Management Franchise Entity Siemrail Vic Ownership Fleet Maintenance Agreement Contractual Relationship (Siemens NRS) 100% Contract Management Siemens Ltd

Veolia Environnement is a listed French company, and Compagnie Générale d'Entreprises Automobiles (CGEA) Connex is its transport subsidiary. Connex Group Australia is the regional operations arm of CGEA Connex, and owns companies operating the monorail and systems and buses in and , as well as .

Under the Connex structure, Connex Melbourne Pty Ltd (“Connex”) is the franchisee.5 Connex is responsible to the State for meeting the requirements of the Franchise Agreement and the Infrastructure Lease, but Connex itself handles only the service delivery aspects of the franchise. Infrastructure maintenance is contracted to a new company called MainCo, via the MainCo Maintenance Agreement. MainCo is 70% owned by Alstom and 30% owned by Connex; it is responsible for all infrastructure maintenance and renewal, rolling stock maintenance, and related project delivery. MainCo sub-contracts the maintenance of existing rolling stock to Alstom Melbourne Transport Ltd (AMTL), a company which is 100% owned by Alstom Australia.

As with the tram franchise, maintenance agreements for the new rolling stock were signed as part of the original franchise deals, and the M>Train NRS maintenance contract was novated to Connex. Connex contracts with AMTL for the maintenance of Alstom NRS, and with Siemrail for the Siemens NRS. However, on a day-to-day basis, AMTL manages the Fleet Maintenance Agreement with Siemrail on behalf of MainCo. AMTL is therefore responsible for the management of all rolling stock, including maintenance, reporting requirements and coordination activities.

More detail on arrangements for supply and maintenance of rolling stock is provided in Section 4.5.

5 Previously (at the time of execution of the Partnership Agreements), Connex’s registered name was Melbourne Transport Enterprises Pty Ltd.

Department of Infrastructure 37 3.2.2 Connex structural agreements

The contractual arrangements for the Connex structure are described briefly below.

• MainCo Shareholders Agreement

This agreement regulates the relationship between the MainCo shareholders. Although Connex and Alstom have a 30%/70% share in MainCo, the MainCo Board comprises three Directors from each. In addition, Connex has the right to appoint the Chairman of the Board, who has a casting vote in the case of a deadlocked vote. Key decisions (eg, major capital expenditure, major sub-contracts, annual budget) must be decided unanimously. The MainCo Shareholders Agreement provides a deadlock resolution mechanism.

The agreement also details MainCo’s dividends and distribution policy and defines the events which give rise to “call options”, giving one shareholder the right to acquire the other’s shareholding. The State’s approval is required before any call option may be exercised, and in addition the State has the right to direct Connex to exercise its option in certain circumstances.

• MainCo Maintenance Agreement

This agreement between MainCo and Connex deals with infrastructure and ERS maintenance, and NRS coordination activities and reporting. The agreement effects a pass-through of infrastructure and ERS maintenance obligations from Connex to MainCo. The scope of works includes infrastructure maintenance (including Metrol) and renewal works, system upkeep, vegetation management, maintenance of ERS (which is then sub- contracted to AMTL) and the management of Electrol.

The agreement specifies the basis of MainCo’s remuneration, provisions for changes to the scope of services, arrangements for the delivery of projects (including sub-contracting and competitive tendering), and the preparation of plans and project documents. OPR penalties and bonuses are shared 75% (MainCo) and 25% (Connex) – but because Connex owns 30% of MainCo, the overall Connex/Alstom split of OPR incentives is around 50/50.

Connex has cure and Step-in rights for MainCo breaches.

• ERS Maintenance Sub-contract

This contract contains provision for ERS maintenance (Comeng and Hitachi vehicles) to be undertaken by AMTL, with a comprehensive pass-through of rolling stock-related obligations and risks from MainCo to AMTL. The contract also covers coordination and reporting of NRS maintenance obligations.

• Separate Maintenance Agreement

Connex contracts directly with AMTL for the maintenance of the X’trapolis NRS; however, AMTL reports through MainCo.

• Fleet Maintenance Agreement

Connex contracts directly with Siemrail for the maintenance of the Nexas NRS, although the contract is managed on a day-to-day basis by AMTL.

3.2.3 Direct Agreements

MainCo and AMTL are not parties to the Franchise Agreement or Infrastructure Lease with the State, but these businesses are central to the operation and maintenance of Melbourne’s railway network. For this reason, Connex was obliged to procure Direct Agreements between the State and counterparties to Connex’s contracts for infrastructure and rolling stock maintenance. Under these Direct Agreements, Franchise Entities:

Department of Infrastructure 38 • are responsible to the State for certain obligations under the Franchise Agreement;

• are obliged to act as if they were the franchisee for certain other obligations, including those relating to corporate structure, “end of franchise” arrangements, and intellectual property;

• must not materially amend, terminate or allow an interest over the underlying contract (without the State’s consent);

• must continue to meet their obligations under the contract in the event that a franchisee becomes insolvent or the State exercises a Step-in right; and

• must continue to meet their obligations under the contract for a specified period after franchise termination, if required to do so by the State.

These Direct Agreements assist in the continuity of passenger services in the event of a franchise becoming insolvent, or at franchise termination.

More detail on Direct Agreements and how these fit into the wider legal framework can be found in Section 5.3.

Parent Company Guarantees:

To further support the delivery of the various contractual arrangements surrounding MainCo and AMTL, Connex and Alstom Australia (and its parent companies) have provided Parent Company Guarantees to the State. These provide additional security to the State by ensuring that the parent companies stand behind the Franchise Entities (which may have limited financial capacity in their own right) and their contractual obligations. This provides comfort to the State that the parent companies will continue to perform the obligations of the underlying contracts if the State exercises its right under a Direct Agreement.

3.2.4 Connex composition and payments

Approximately 2,600 full time equivalent (FTE) staff are employed over the three entities of the Connex structure, split as shown below. Total costs across the three entities are around $500 million per annum. MainCo is a sizable company, with a cost base around $100 million per annum.

Employees (FTE) Total Costs

20%

17%

Connex Connex MainCo MainCo AMTL AMTL 76% 10% 7% 70%

Department of Infrastructure 39 Basis of remuneration:

Payments for the three businesses are provided as shown in the table below. In all cases, payment to MainCo and AMTL comes from Connex.

Connex MainCo AMTL Farebox revenue & Base remuneration Fixed monthly fee Fixed monthly fee franchise payments Less amount withheld in escrow 6 !! account 75% of variance +/- OPR regime adjustment ! against Offer Up to 10% of Up to 10% of Failure to meet KPI targets n/a monthly fee monthly fee Project milestone payments !!! Rolling stock adjustment ($/km)7 !

Details of the financial structuring arrangements covering the Connex Franchise Entities can be found in Section 4.3.3.

3.3 Metlink

3.3.1 Background

As discussed in Section 2.3.2, none of the network-wide bodies established during the 1999 rail franchising process had a clearly defined mission or a direct contractual relationship with the State, even though, as long term “owner” of the public transport system, the State had a vital interest in ensuring that network-wide functions were performed effectively.

The shareholding and managerial arrangements of RCH, VicTrip and MPGI were anomalous and inconsistent. A representative of V/Line sat on the board of VicTrip but not RCH or MPGI. The Government represented buses on the RCH Board, but the Bus Association of Victoria performed that role on the MPGI Board. The CEO and Chairman of RCH were also CEO and Chairman of VicTrip, but not of MPGI.

Three organisations existed to perform functions – ticketing, marketing and passenger information – which were clearly heavily interlinked, but these organisations were culturally and institutionally separate from each other.

The diagram on the next page represents the previous structure.

6 See Section 4.4.1. 7 See Section 4.9.1.

Department of Infrastructure 40 State State (Director) (PTC)

Infrastructure Leases

Franchise Agreements

V/Line M>Tram M>Train Yarra Trams Connex Passenger

OneLink Service Contract Revenue MPGI VicTrip Clearing House

Contract management OneLink Transit

The refranchising of metropolitan rail services and the establishment of “one train, one tram” provided an opportunity to put this right. Metlink took over the ticketing, marketing and passenger information functions of the RCH, MPGI and VicTrip. It is also responsible for new industry-wide functions such as coordination of complaints handling processes, and the collection of data on patronage and fare evasion.

Just as importantly, through the new Metlink Services Agreement, Metlink is directly accountable to the State (as well as to the operators) for its performance. Its objectives, obligations and service standards are closely defined for the first time, removing the anomalies, overlaps and ambiguities which characterised the old regime.

3.3.2 The Metlink organisation

Metlink is a non-profit body. It is owned by the two metropolitan rail operators (Yarra Trams and Connex), but also includes on its Board representatives of the metropolitan bus industry (represented by the Bus Association of Victoria). The franchisees own shares in Metlink for the duration of their Partnership Agreements; after these agreements expire, the shares will transfer to the State or to successor operators. Provision exists for ownership to be extended to V/Line when this is refranchised, and to the bus industry when new bus contracts are established which include bus companies taking revenue risk.

Metlink’s central objective or mission is:

To secure substantial and sustainable increases in public transport use and farebox revenue in Melbourne through improvements in key aspects of the network-wide product and marketing mix over which it has control.

As a secondary objective, Metlink also aims to assist V/Line and regional transport operators to grow patronage.

Department of Infrastructure 41 Metlink is responsible for the following functions:

• marketing and customer information;

• revenue collection and allocation;

• ticketing and revenue protection;

• public transport policy and advocacy; and

• data collection and analysis.

The details of these are discussed in Section 4.10. What these all have in common is a reliance on cooperation between operators. Metlink is responsible for most of the services in the metropolitan public transport industry which can only be delivered effectively by operators working together. Metlink’s objective to grow patronage and revenue is most likely to be achieved if all parties work together, and the creation of Metlink is designed to promote this.

For most of its activities, Metlink’s primary focus is metropolitan. However, with respect to the provision of information on public transport, Metlink provides information on services across all of Victoria, thereby assisting both metropolitan and regional operators grow ridership.

Metlink has approximately 40 full time staff, and its annual budget (excluding OneLink payments) is around $20 million (see Section 3.3.5).

The new structure is represented below.

TTA OneLink OneLink Service Contract

100%

State (Director)

Franchise Agreement Franchise Agreement Infrastructure Lease Infrastructure Lease etc. etc. Metlink Services Agreement Metlink Shareholders Agreement Yarra Connex Trams

50% 50% Train Operator Tram Operator Services Services Agreement Agreement Metlink

OneLink Management V/Line Services BAV Services Agreement Agreement Agreement

V/Line Bus Assoc’n Passenger of Victoria

Department of Infrastructure 42 3.3.3 Contractual framework

The contractual framework supporting Metlink is based on the following main documents:

• the Metlink Services Agreement, which sets out all the services the Director of Public Transport is purchasing from Metlink and the payment regime for those services;

• the OneLink Management Agreement between the Director, Metlink and TTA, which describes the delegated role which Metlink will play in the day-to-day management of the existing OneLink Service Contract;

• the Revenue Sharing Agreement between the Director, Connex, Yarra Trams, V/Line and Metlink, which describes how revenue will be collected by Metlink on behalf of the operators and the Director and distributed between them; and

• Operator Services Agreements between Metlink and each of the main operators (Yarra Trams, Connex, V/Line and the Bus Association of Victoria), which set out the obligations of the parties to supply services to each other and the related funding arrangements.

3.3.4 Metlink governance

The governance arrangements for Metlink are set out in the Metlink Shareholders Agreement and are further documented in a Corporate Governance Plan produced by Metlink and approved by the Director of Public Transport.

Composition of the Board:

The Board of Metlink comprises seven directors appointed as follows:

• Connex – the CEO of Connex (or equivalent) and a senior representative of Connex (Train Directors);

• Yarra Trams – the CEO of Yarra Trams (or equivalent) and a senior representative of Yarra Trams (Tram Directors);

• Bus Association of Victoria (BAV) – the CEO of a metropolitan bus operator and a senior representative of the BAV, each appointed by the BAV (Bus Directors); and

• Independent Director – a person jointly nominated by Connex, Yarra Trams and the BAV, who is independent of those operators and not an employee of Metlink. The Independent Director acts as the chairman of Metlink.

Any change to the Chief Executive Officer of Metlink must be approved by the State.

Voting rights at Board Meetings:

A three-tiered voting structure applies at Board Meetings:

• Simple Majority – most matters coming before the Metlink Board will require the approval of at least five Directors who are present and voting at the meeting;

• Special Majority – key matters with major financial or commercial implications for Metlink’s shareholders require a Special Majority – that is, the approval of at least five Directors including at least one Train Director and one Tram Director; and

• Unanimous Vote – a unanimous vote of the Board is required to approve the Network Marketing Strategy.

Department of Infrastructure 43 Voting rights at shareholder level:

For legal reasons, the shareholders of Metlink (Yarra Trams and Connex) need to meet separately from time to time. Only matters which are specifically identified in the Corporations Act (eg, change of company name) will be decided at a Shareholders' Meeting. All other matters must be decided at Board Meetings.

Governance Plan:

Metlink has a Corporate Governance Plan, which sets out how Metlink will deal with compliance, corporate governance and risk management issues. The plan includes delegations designed to enable Metlink to manage its activities efficiently and effectively.

Metlink indemnities:

Under the Metlink Services Agreement, Metlink provides an indemnity to the Director of Public Transport in respect of any loss and damages suffered by the Director as a consequence of:

• an act, omission or neglect on the part of Metlink or its subsidiaries;

• any breach by Metlink or its subsidiaries of its key contracts;

• any infringement by the Director of Public Transport of intellectual property rights not owned by Metlink; or

• the occurrence of a Termination Event or Step-in Event.

Under the OneLink Management Agreement, Metlink provides an indemnity to the Director and TTA in respect of any loss they suffer as a consequence of a breach by Metlink or a Termination Event or Step-in Event under the OneLink Management Agreement.

The indemnity in favour of the Director under the Metlink Services Agreement and the OneLink Management Agreement (which is backed by the franchisees’ Performance Bonds) is capped at $25 million.

3.3.5 Funding framework:

Metlink funds its activities from a number of sources. Its core functions, including its in-house running costs and outsourced activities such as the public transport call centre and website, are funded through:

• a Director Services Payment, paid by the State, which is specified in the Metlink Services Agreement and amounts to approximately $8.4 million per annum; and

• contributions from Connex, Yarra Trams and V/Line (around $2 million per annum each), which are set out in each Operator Services Agreement.

If Metlink requires more funding in any given year than is provided from these sources, its shareholders (Yarra Trams and Connex) are required to provide additional funds. If Metlink spends less than it receives in any year, the surplus money is retained by Metlink and carried forward to the following year. Each year, Metlink submits to the State a Business Plan and budget outlining how the money it receives is to be spent.

In addition to the Director Services Payment and the franchisees’ contributions described above, Metlink receives a Network Marketing Payment from the State which is fixed at $5 million per annum and, under the terms of the Metlink Services Agreement, can only be spent on defined and agreed marketing activities.

Metlink’s funding arrangements are shown graphically on the next page.

Department of Infrastructure 44 Metlink State Services (Director) Agreement

Network Director $8.4m Services Marketing $5m Payment Payment

METLINK

Operator $0.12m Services $2.2m $2.2m $2m Agreements

Yarra V/Line Bus Assoc Connex Trams Passenger of Victoria

In the past, OneLink was funded by the Revenue Clearing House on the basis of payments from franchisees and the State. Under the new arrangements PTD pays OneLink directly for the full costs of operating the existing ticketing system. Metlink’s role is simply to calculate the payments which PTD is to make to OneLink and advise the State accordingly. The only exception is where the operators themselves initiate a variation to the OneLink contract which increases the payments to OneLink. In these circumstances, Metlink collects a contribution from each affected operator and passes the money through to PTD, from where it is paid on to OneLink.

3.4 Summary of roles and responsibilities

Under the new franchises, responsibility for key areas has been allocated as shown in the table below:

Key Service Area Connex Franchise Yarra Trams Franchise Train/Tram operations Connex Yarra Trams Customer service Connex Yarra Trams Revenue protection Connex Yarra Trams Infrastructure maintenance MainCo Yarra Trams Existing rolling stock maintenance AMTL Yarra Trams AMTL (Alstom NRS) Alstom Australia (Alstom NRS) New rolling stock maintenance Siemrail Vic (Siemens NRS) Siemrail Vic (Siemens NRS) Revenue allocation Metlink Metlink Marketing and customer information Metlink Metlink Long term system planning DOI DOI

Regardless of any sub-contracting arrangements, the franchisees are legally responsible to the State for all obligations under the Partnership Agreements (although the State has certain rights directly against MainCo and AMTL pursuant to the Direct Agreements).

Department of Infrastructure 45 Department of Infrastructure 46 Chapter 4: Contract Design

The Refranchising Process used as a base the contracts associated with the original public transport franchising of 1999. However, the switch to one train, one tram, and the creation of Metlink, represented a significant departure from the previous franchising structure and had implications for the design of the new contracts. Much of the material from the 1999 agreements was retained, particularly the principles of the Passenger Services Requirements and the Operational Performance Regime.

At the same time, changes were made to the contractual arrangements, particularly the Franchise Agreements and Infrastructure Leases, to rectify problems in the original versions or to make improvements developed from the experience gained over the previous three years.

This chapter details each individual aspect of the design of the Partnership Agreements, together with a discussion of the rationale where principles have changed from the original 1999 franchising arrangements.

4.1 Operations and service delivery

4.1.1 Passenger Service Requirements

Given that revenue generated by public transport services is not sufficient to cover the cost of operating these services, the Government needs to specify in some detail the level of service which franchisees are required to provide. A more laissez-faire approach might result in significant cuts in service levels, which the Government is unwilling to contemplate. The policy objective for the Government is to maintain overall service levels, while ensuring that the detailed timetables adopted by the train and tram operators are not locked in for all time. Changing patterns of travel and distributions of population during the terms of the franchise contracts could not be addressed unless operators enjoyed at least some flexibility to alter service provision.

The solution adopted is the Passenger Service Requirement (PSR), which lies at the heart of the Franchise Agreement, and requires the franchisees to provide at least the same overall level of service (measured in train or tram kilometres) as that provided at the beginning of each franchise – but with some flexibility to redistribute service levels on and between individual routes to match demand.

The PSR requires each franchisee to operate a level of passenger service at or above specified minimum service levels. It provides a set of simple rules, specifying the overall service levels which must be provided by each franchisee, as well as the minimum number of services to be operated on particular train and tram routes. It also requires, through the use of load standards, that additional services be provided to ease any overcrowding which occurs. The franchisee can propose changes to timetables provided it maintains the minimum services required under the PSR and meets load standard obligations.

The original Franchise Agreement used a headway-based PSR, setting out the maximum gap between services that was permissible for each of six timebands (fewer on weekends) throughout the day. There were a number of problems with this approach:

• difficulty for franchisees in dealing with the timeband interfaces, particularly where a large “step” was involved (eg, from 12 minute headways to 30 minute headways);

• problems of “technical non-compliances”, where a franchisee might be non-compliant by just one minute;

• infrastructure limitations (notably on lines with sections of single track) leading to unavoidable non-compliance; and

• a complex and time-consuming timetable change procedure for all changes, including minor amendments.

Department of Infrastructure 47 In the new Franchise Agreement, the State revised the specification of the PSR to provide franchisees with greater flexibility to amend timetables, while ensuring that an appropriate minimum level of service continued to be provided to all passengers. The aim was to provide a contractual environment where franchisees were encouraged to provide customer-focused and innovative services without incurring purely technical breaches of franchise conditions, within an approval process appropriate to the level of change contemplated.

Under the new Franchise Agreement, the following changes were made to the structure of the PSR and timetable change process:8

• the PSR template was changed to specify the minimum number of trips to be provided by day, timeband, direction and station (trains) or route (trams), rather than maximum headways;

• for each timeband on each tram route or train “route section” the PSR sets out the minimum number of services which must be run, but also includes a number of services (usually around 10% of the total) which the franchisee can allocate as it chooses within timebands and across routes/“sections”, provided that load standards are not breached and passenger service is not adversely affected;

• timebands have been shortened (most are now two hours) and the number across a weekday increased to eight; and

• average and maximum journey times are no longer specified as part of the PSR. The franchisee can propose an increase in journey times as part of a timetable change, which must be substantiated and which is subject to the approval of the State. The OPR target will be adjusted for any journey time change (see Section 4.2.1).

In addition, the PSR specifies:

• the minimum number of train and tram kilometres that must be run each year – franchisees are prevented from reducing total service kilometres from the levels existing at July 2003;

• the latest departure time for the first service of the day;

• the earliest departure time for the last service of the day;

• the levels of service to be operated on public holidays – generally a level of service appropriate for a Saturday or Sunday;

• reduced service levels during the Christmas holiday period – reflecting the significant reduction in passenger numbers during the few weeks after Christmas. This also allows franchisee operational staff to take leave;

• the levels of service to be provided on New Year’s Eve each year – services to be operated all night on the train network and until 2.00am on the tram network;

• that substitute services must be provided where train or tram services are blocked for any reason (eg, by a Special Event, parade, track occupation or accident); and

• for train, the minimum level of service which is to operate through the City Loop, and the direction in which these services must run.

8 More detail on the principles and processes of timetable changes is provided in the Timetable and Service Changes Practice Note.

Department of Infrastructure 48 Timetable change procedures:

The Franchise Agreement specifies the procedures which are to be followed if the timetable or the PSR which regulates the timetable are to be altered. These procedures can be summarised as follows:

• the franchisee may provide any services it wishes in addition to the minimum level of service required under the PSR;

• the State can impose PSR changes as it sees fit, but will be required to compensate the franchisee for the net costs associated with any extra services it is required to run; and

• if a franchisee wishes to make amendments to its timetable (which it may not do more than once every six months for a given route) it must:

o consult with operators of connecting services to ensure better intermodal connections; and

o obtain the State’s approval for the timetable change. The process for this allows minor timetable changes to be fast-tracked through the system, but provides for detailed review of major changes with significant planning, coordination, consultation, policy or budgetary implications.

Overcrowding:

By specifying a minimum level of service, the PSR provides a basic safeguard against severe overcrowding on the train and tram networks. Since overall service levels cannot be cut, and adjustments in service provision on particular lines are specifically constrained, franchisees cannot seek to save costs by cramming more and more passengers on to fewer vehicles. That said, the Government is keen to ensure as far as possible that patronage growth does not lead to unacceptable levels of overcrowding. The Franchise Agreement therefore contains a mechanism for monitoring and managing crowding, ensuring that emerging capacity problems are identified early and that franchisees take reasonable steps to address them.

Overcrowding is measured in relation to predetermined “load standards”. These specify the average thresholds above which vehicles are deemed to be overcrowded. For instance, they specify the numbers of standing passengers that can be accommodated on vehicles of a given size before overcrowding is deemed to have occurred. Load standards for trams are stricter outside Melbourne’s CBD than inside, reflecting the existing patterns of demand within Melbourne and the propensity of passengers to make short trips within the city on which standing would cause relatively little discomfort. Similarly, load standards on metropolitan trains are stricter in the off-peak than the peak. The standards do not impose a restriction on the number of passengers that can be carried on a particular vehicle. Rather, they impose a regulatory benchmark based on the average load over a one-hour period which, if breached, triggers a series of remedial obligations on franchisees. Half yearly surveys are used to gauge whether load standards are being breached.

If overcrowding problems do emerge, in the first instance franchisees are required to improve “fleet utilisation” – ie, to run extra services by reducing the amount of time that train and trams lie idle in maintenance workshops. The next level of recourse is for the franchisee to propose to the Government a redeployment of vehicles across its network in order to address overcrowding problems on particular lines.

Beyond these basic responses, the Government can, if it wishes, direct the franchisee to acquire additional new vehicles, with the Government providing the required funding. Alternatively, it could be decided to refurbish the small number of older train (Hitachi) and tram (Z1/2 Class) vehicles which are required to be stored by the franchisees to cope with the increased demand during the Commonwealth Games.

Department of Infrastructure 49 4.1.2 Special events regime

While the PSR establishes minimum service levels for daily operation, there is also a need to cater for special events, particularly in Melbourne. Major festivals and sporting fixtures bring thousands of extra passengers into the city, and a regime is required to ensure that franchisees respond efficiently and flexibly to these periodic demands.

The special events regime contained in the Franchise Agreement takes as its starting point a pre- determined number of train and tram kilometres which operators have traditionally run each year, in addition to the normal timetable, to service special events. Franchisees are required, at their own expense, to continue to provide this extra quantum of services (the Special Event Minimum Input), for events nominated by the Government. If they are required to run services in excess of the Special Event Minimum Input (eg, for new events), they receive additional payments from Government, determined on the basis of a fixed amount per train or tram kilometre. This approach allows the Government to require additional services to be run, without the need for protracted haggling with the franchisee over an appropriate level of compensation. In the event that the number of service kilometres operated to special events in a year is less than the Minimum Input, the franchisee must make a payment to the State.

Where the State requires a franchisee to provide special event services outside of normal operating hours, the franchisee will be obliged to run these services but the State will meet the reasonable direct costs which arise.

Each year, the State issues a list of all designated special events for which services additional to the normal timetable will be required, to which franchisees must respond with an indicative plan of services. In addition, franchisees must provide to the State detailed plans before, and debrief reports after, each event.

Parades and festivals:

Parades and festivals are planned external disruptions to tram services. After commencement of the original franchise arrangements, the tram franchisees could claim costs arising from disruptions caused by street parades and festivals (eg, costs of passenger notification and provision of replacement buses, but not OPR penalties, which would be mitigated) from festival organisers (usually local councils or traders’ associations). This resulted in several large claims from tram operators, particularly in relation to a handful of big events (eg, St Kilda Festival), leading to complaints to the Government by festival organisers and threats that costs were prohibitive and would cause future events to be cancelled.

In response, the Government and the tram franchisee have agreed that the amount the franchisee can claim from festival organisers will be capped at $5,000 per event (or $10,000 for events which disrupt trams on more than one street).

4.1.3 Staffing, security and revenue protection

Generally speaking, it is for franchisees to determine the level, composition and deployment of staffing resources across the rail system, and to agree appropriate arrangements to this end with the unions and provide employees. However, in order to safeguard service quality and for the efficient and consistent protection of revenue, the Government set a series of minimum staffing obligations in the Franchise Agreement which effectively increased the number of staff on the train and tram networks.

A great deal of work was done by the Refranchising Team and the franchisees during the Refranchising Process on the best utilisation of staffing resources, particularly in relation to the mix of customer service, revenue protection and passenger security duties. Passenger security was a major issue in the media and in perceptions of the public transport system.

The Franchise Agreement requires the franchisees to employ a minimum number of Authorised Officers. This was primarily designed as part of the strategy for revenue protection, although the State also recognised the importance of customer service and security. Minimum ticket checking rates were not included because the complexity of administering these would be prohibitive. The

Department of Infrastructure 50 State has an option to reduce the minimum number of Authorised Officers required if a franchisee can show that it has improved ticket checking rates to the extent that fewer Officers are necessary.

Under the Franchise Agreements, the franchisees are required to employ:

• Connex – at least 290 (FTE) Authorised Officers in mobile, customer-facing roles; and

• Yarra Trams – at least 215 (FTE) Authorised Officers in mobile, customer-facing roles. In addition to this, under the terms of a side letter, Yarra Trams must employ 50 staff in customer service positions. The primary focus of these staff is to assist passengers with any difficulties they may have – eg, by providing information or assisting with boarding or alighting from trams – but they may also be authorised.

While the franchisees are broadly free to deploy these staff as they see fit, they must comply with a number of requirements relating to staffing and revenue protection under the Franchise Agreement. While Yarra Trams has few specific obligations under the Franchise Agreement in respect of its revenue protection activities, there are a number of minimum requirements for staffing deployment on the train network.

Under the train Franchise Agreement, Connex must ensure that the ticket barriers at all entries to and exits from platforms at Flinders Street, Spencer Street, Richmond and City Loop stations are either closed or constantly under direct staff supervision from 7.00am to 10.00pm each day of the week. This is designed to provide a degree of system closure and consistency in revenue protection (previously, particularly with two operators managing these stations, treatment of barrier closure was patchy and unpredictable for passengers). A requirement for barrier closure from first to last train every day was not found to be cost effective.

Connex is also required to deploy at least two Authorised Officers on every train after 9.00pm for at least 80% of the journey. This initiative built on the safe travel staff introduced in 2001, but made the presence of security staff more extensive and predictable. Research undertaken by the industry found that the main security issues on public transport were ones of perception, and the perceived problems were particularly on board trains after dark. Having officers on every train provides a level of reassurance and certainty to passengers. Because staff may be required to leave the train to attend to security problems at stations or to remove an offender, the requirement for staff presence was for 80% of the journey only, to allow some leeway. 9.00pm was chosen, as trains prior to this time tend to be more heavily loaded, and the cost of providing the security staffing would have been prohibitive giving the number of trains operating earlier in the evening.

Discussions between Connex and the State led to an agreement for Connex to provide staff at 31 additional stations in the morning peak, and 20 stations (on a rotating basis) in the afternoon peak, concentrated at stations with high patronage or serving schools. This provided a revenue protection benefit in the morning by ensuring more passengers bought and validated tickets prior to travel, and also responded to widespread calls during refranchising (spearheaded by public transport unions) for more station staff. The afternoon staffing arrangements were designed to provide security and property protection at the times and places where research showed vandalism and safety issues were most prevalent.

Revenue Protection Plans:

Revenue protection had been problematic during the first franchise period, with fare evasion running at high levels, no coordinated strategy to tackle it and no reliable measurements to assess the extent of the problem. It was recognised during the Refranchising Process that no single solution was likely to solve the problem, and so the new contracts contained a range of measures to secure a reduction in fare evasion, of which the most significant two were:

• the revenue allocation split – the 40% share for the tram operator was significantly higher than would be provided if farebox revenue was split according to the amount generated by each mode. This was designed to increase the reward and therefore the incentive on the tram franchisee to improve its revenue protection performance; and

Department of Infrastructure 51 • Revenue Protection Plans – during the first few months of the franchise, each franchisee produced an initial Revenue Protection Plan which outlined the franchisee’s strategy for revenue protection, including:

o the types and numbers of staff who would be performing revenue protection duties, including a breakdown by forecast working hours of the other functions which they would perform (passenger information, security, customer assistance, etc);

o protocols around staff behaviour and work practices;

o training programs for Authorised Officers, including “refresher” courses; and

o strategies for deploying staff across the network.

Under the Metlink Services Agreement, Metlink is responsible for production of a Network Revenue Protection Plan, which integrates the franchisee’s mode-specific Revenue Protection Plans to provide coordinated revenue protection activities across the whole public transport system. Metlink is also responsible for undertaking surveys and other activities to collect data to measure the extent and types of fare evasion across the public transport system. Each year, the franchisees, Metlink and the Government work to update the Network Revenue Protection Plan, which is binding on Metlink and the franchisees.

Administration of fines:

As employees of private companies, Authorised Officers employed by the train, tram and bus operators are not able to issue fines directly to passengers who commit transport infringements. Instead, when an offence is detected, the Authorised Officer writes out a Report of Non-Compliance, which is sent into the Department of Infrastructure. The Department of Infrastructure then issues a Transport Infringement Notice (fine) to the offender, and revenue from the fine accrues to the State. Under the Partnership Agreements, the train and tram franchisees are entitled to an administration fee of $20 for each fine paid. The State pays this amount to the franchisees to offset the enforcement costs of revenue protection activities across the train and tram networks.

4.1.4 W Class and heritage trams

Under the original Franchise Agreements, tram franchisees were required to run a total of 53 W Class trams on the City Circle route and routes 8, 12 and 16. These trams were taken out of service in 2001 after concerns about their brakes and crashworthiness.

The Risk Assessment Report on W Class trams recommended that for safety reasons they be run on routes where interfaces with other trams could be minimised. With this in mind, route 30 (along La Trobe Street) and route 78/79 (Chapel Street) were chosen to run the trams (as well as the City Circle route). Not only were these routes relatively self-contained, they also ran in areas where running speed was already constrained and could therefore minimise the impact of the W Class trams’ limited speed. Owing to the slow average speeds throughout the CBD area, it was decided to retain the W Class trams on the City Circle route. While 53 trams are not necessary to fulfil these requirements, the franchisee must maintain 53 W Class trams in operational condition and operate them on a rotating basis. This ensures the trams are available should they be needed for an expanded role (eg, for a new tourist route) in the future.

The tram Infrastructure Lease contains a provision requiring the franchisee to maintain the infrastructure to allow trolley pole tram operation on certain parts of the network. These areas are prescribed in the Infrastructure Lease for W Class trams. Even if all W Class trams are fitted with pantographs, the State has the right to nominate areas of the network which must still be available for trolley pole operation, to ensure access to heritage trams for special parades or events.

4.1.5 Station facilities

The train franchisee is required to undertake a number of improvements to facilities at stations, including car parking, bicycle storage facilities and station lighting.

Department of Infrastructure 52 Car parking:

Under the original Bayside Trains Franchise Agreement, the franchisee was required to undertake a pilot project to test the customer demand and likely success of a roll-out of secure car parking at stations. M>Train got no further than initial design on this project, but it was generally recognised that such a pilot project was likely to be beneficial, particularly given the relatively high level of theft of and from cars parked at stations.

A smaller pilot project was mandated as part of the new arrangements.

Bicycle lockers:

The provision of maintained and secure bicycle lockers at stations encourages passengers to ride to stations and complete their journey by train – an important objective of the TravelSmart behavioural change program. However, under the initial franchising arrangements bicycle lockers had been neglected, with no consistent management and organisation from station to station, let alone between train operators.

In order to provide an understanding of the state of bicycle facilities at stations so that comprehensive management policies can be put in place, the new Franchise Agreement provides a right for the State to undertake an audit of all bicycle facilities at railway stations within three months of commencement. The train franchisee is required to ensure that the current number of bicycle lockers at stations is maintained to a specified minimum standard (with routine painting and graffiti removal).

Lighting:

Customer surveys indicated that the brightness and colour of lighting at railway stations, car parks, and passenger entrance and exit points, and particularly the use of yellow lighting instead of white lighting, are key factors in influencing passenger perceptions of safety and security when using public transport services.

For this reason, it was proposed to explore the possibility of improving station lighting under the new Franchise Agreement. Instead of mandating improvements (which may not turn out to be achievable in practice), the franchisee is required to audit lighting and develop an action plan identifying locations where upgrades in respect of light amplification/illumination levels and colours would be practicable to implement, including costings of the proposed upgrades. If approved by the State, the franchisee must then undertake the works detailed in the plan, with funding provided by the State.

4.1.6 Livery, uniforms and branding

By the end of the first franchise period there were at least ten different company names on vehicles, maps and signage, and several hundred different styles. This was confusing for passengers, particularly given the upheaval of the previous few years. To make it easier to navigate the system, each franchisee is required under the new Franchise Agreement to establish a single consistent livery for its rolling stock and a single uniform for its staff within the first year of the franchise.

The Metlink trademark must be displayed on all rolling stock, signage, timetables and maps, to send a clear and consistent message to passengers about the reunification of the public transport system. Metlink is required to produce and maintain a Master Style Guide setting out the style and formatting of all passenger information and publications, to which franchisees are required to conform.

4.1.7 Customer Service Charters

To ensure passengers know what they are entitled to expect from the services provided by franchisees, each franchisee is required to produce and periodically update a Customer Service Charter. These Charters must be in a standardised format, cover key issues in relation to the rights and responsibilities of passengers, be produced in languages and formats which maximise their accessibility for the travelling public, and be promoted actively by the franchisees. The Franchise Agreement provides a template for Customer Service Charters which has been discussed with the Public Transport Customer Charter Committee and ensures all key areas are covered.

Department of Infrastructure 53 4.1.8 Complaints handling and the Public Transport Industry Ombudsman

Complaints about public transport under the previous arrangements had gone to the operators directly, or to VicTrip, OneLink, PTD or the Minister for Transport. Recourse to the Victorian Ombudsman was removed at privatisation as the Victorian Ombudsman can deal only with complaints about Government agencies. There were no overall minimum standards for responding to complaints, and the quality and timeliness of responses varied significantly between agencies and between individual officers within an agency. Often complaints got passed around from one agency to another.

Given the importance of complaints handling for customer satisfaction, one of the priorities to come out of the Refranchising Process was the necessity to bring in a consistent process with minimum response standards across the public transport industry. With this in mind, the Franchise Agreement requires each franchisee to comply with the Australian Standard for complaints handling (AS 4269-1995). Under the new arrangements, all public transport operators must subscribe to a complaints handling procedure drawn up by Metlink. The procedure ensures that complaints received by any operator (or Metlink) are dealt with promptly by that operator, or forwarded on to the relevant operator for rapid response. Complaints about overall public transport policy or planning still go to PTD.

In addition, the Government decided to establish a Public Transport Industry Ombudsman to provide independent advice and assistance in relation to complaints made by the public, and to whom complaints can be referred if they are not resolved to the complainant’s satisfaction. The Public Transport Industry Ombudsman (Victoria) Ltd (PTIO) is a company limited by guarantee, with a Board of Directors consisting of three Directors appointed by the train, tram and bus operators, three Directors from consumer organisations selected by the Minister for Transport, and an independent Chairperson. The Board is responsible for appointing the Ombudsman.

The PTIO deals with complaints about:

• public transport services (trains, trams and buses);

• sale of tickets, including ticket machines, ticket retailers and ticket refunds;

• infrastructure and rolling stock, including graffiti, vandalism and cleanliness; and

• the conduct or behaviour of franchise employees and their agents or contractors, except Authorised Officers (who are covered by the Victorian Ombudsman as they exercise statutory powers).

The establishment and start-up costs for the PTIO were funded by the State; ongoing costs are met by the operators through fees comprising fixed and variable components based on the size and number of complaints generated by each operator.

4.1.9 Fares

Public transport performs an essential social function which is central to the operation of an egalitarian society. As such, the Government has a keen interest in seeing that public transport services are available to as wide a cross-section of the community as possible. Since competitive pressures in themselves are insufficient to prevent franchisees increasing fares, under the Franchise Agreement increases in fares are capped in line with the Consumer Price Index (CPI). By international standards, travel on Victorian public transport is cheap and, consistent with experience elsewhere, demand is relatively price inelastic.

The Franchise Agreement regulates the range of tickets which franchisees must make available to passengers, preserving the current range of tickets and the multi-modal, zone-based fare structure. Single-operator tickets, which franchisees were able to introduce under the previous franchising arrangements, serve only to dilute the revenue pool in an environment where farebox revenue allocation is fixed. For this reason, the operators removed these tickets from sale. New single- operator tickets can only be introduced with the support of all franchisees, Metlink and the State.

Department of Infrastructure 54 The Franchise Agreement contains a regime for reimbursing franchisees for concession travel, which generally costs 50% of the price of an equivalent full fare ticket. Franchisees are compensated directly for passenger journeys made on concession tickets, but not for 100% of the value of an equivalent full fare: price elasticities are such that operators gained some revenue benefit from the extra patronage that cheap concession fares generated. For each concession ticket sold, the Government funds only half the gap between the concession ticket and full fare: concession revenue is topped up so that operators would generally receive 75% of the value of the equivalent full fare. To prevent any abuse of this reimbursement system, Metlink conducts regular surveys to ascertain the proportion of passengers travelling on concession tickets who are not entitled to do so, and the reimbursement amount is adjusted to compensate for this.

Free travel concessions (including Seniors’ Week) are also protected, with a specific reimbursement mechanism set out in the Franchise Agreement.

4.2 Incentive mechanisms

Although in theory the commercial pressure on franchisees to grow revenue ought to serve as a driver of improved service quality, additional, direct incentives and penalties were introduced in order to further sharpen franchisees’ focus on key service attributes like punctuality and reliability. Incentive mechanisms under the original franchising arrangements were generally successful (with the exception of the Passenger Growth Incentive, which was scrapped – see Section 1.5.2) and were retained in the new Partnership Agreements. A number of improvements were made to the Operational Performance Regime, and two new incentives regimes were introduced to further encourage franchisee performance.

4.2.1 Operational Performance Regime

The Operational Performance Regime (OPR) encourages train and tram operators to deliver a punctual and reliable service to passengers. Their performance is monitored and logged, and the results are then compared to targets specified in the Franchise Agreement. Franchisees receive additional cash payments from the Government if, in a given month, their performance is better than the target. They pay penalty payments if they fail to meet the target.

The OPR was one of the main successes of passenger rail franchising. By linking financial rewards to the punctuality and reliability of the trains and trams, the franchisees were incentivised to reduce delays and cancellations by an average of 35% over the four years of the original franchise arrangements.

Performance data:

The movement of every train and tram service on the network is monitored at various points on each route. For tram services, this monitoring is performed automatically through the Automatic Vehicle Monitoring (AVM) system. For trains, a manual monitoring system currently operates, with staff logging the arrival and departure of each vehicle at its destination and point of origin. This manual system is subject to independent data quality audits, and will soon be replaced with an automated train monitoring system.

The following types of service failure are recorded:

• delays – trains or trams running late;

• early running – trains or trams departing or running early;

• short shunting – trains or trams failing to depart from their timetabled point of origin or turning back before arriving at their timetabled destination;

• bypass – trains running direct to/from Flinders Street Station when they are timetabled to operate via the City Loop and/or the Westona Loop; and

• cancellations – train or tram services failing to run at all.

Department of Infrastructure 55 Operational performance on each route is measured at a number of monitoring points, specified in the Franchise Agreement. For trains, performance is monitored only at the origin and destination of the service, and for intermediate bypass, as shown below:

Origin Destination

1 2 3

Cancellations Loop Bypass Cancellations (if applicable) Short Short Shunting Shunting Early Running - - Late Arrival

For trams, a much more detailed monitoring arrangement exists, with three intermediate monitoring points on each route to identify the extent of any early running or short shunting:

Origin Destination

12 3 4 5

Cancellations Cancellations Cancellations Cancellations Cancellations Short Short Short Short Short Shunting Shunting Shunting Shunting Shunting - Early Running Early Running - - - - Delays (Late) Delays (Late) -

Monitoring points 2 and 4 are generally very close to the terminal monitoring points. These are designed to ensure the tram franchisee is not penalised for a service which is delayed for a significant amount of time while waiting for the terminus to clear of the tram which operated the previous service.

Passenger weighted minutes:

Performance is measured in “passenger weighted minutes” (PWMs). A time value (in minutes) is attributed to each delay or service failure. The time value for delays is a straightforward measurement of lateness. Pre-determined time values are also attached to cancellations, short shunting (depending on the number of stops which are missed), bypass (train only), and early running (which normally attracts twice the time value of late running, to reflect the fact that passengers may miss an early service even if they turn up at their station or on time).

These time values are then multiplied by a pre-determined “passenger weighting” – an estimate of the number of passengers travelling on each service. Weightings, which are specified in the Franchise Agreement, vary by route and by time of day. A 10 minute delay to a crowded peak hour train will attract a heavier PWM rating than a similar delay to a lightly used, off-peak train service on the same route.

Department of Infrastructure 56 Planned and Unplanned performance:

The OPR measures the extent to which operators run services in conformity with their timetables – both the long term “Master Timetable” and the “Daily Timetable” (which is produced in the light of any engineering work or other factors which necessitate temporary adjustments to operating schedules). Targets based on records of the previous performance of the network have been established for:

• Planned Performance – the extent to which the Daily Timetable (which must be notified to passengers seven days in advance) conforms with the long term, published Master Timetable. For example, engineering work which will disrupt services is known in advance and passengers can be given prior warning of the disruptions; and

• Unplanned Performance – the extent to which actual performance conforms with the Daily Timetable. For example, a late driver will cause a delay which is unforeseen and passengers cannot be warned beforehand.

It is a fact of life that some delays and cancellations are inevitable. Nonetheless, with a concerted effort, delays and cancellations can be reduced, and targets have been set which are both challenging and become steadily more demanding over time. The new OPR targets and route details for the combined train and tram businesses were established by a simple merging of the two previous train and tram OPR targets and route details. These targets are reset to become more demanding every twelve months, as shown in the graph below.9

OPR Targets

300 PTC 280 260 1999 franchise 240 targets New franchise 220 targets Tram 200 Train

(million) 180 160 140 120 asne WeightedPassenger Minutes 100

0 5 7 8 /0 0 9/0 1/02 4 6/0 8/09 1998 9 0 0 0 0 000/01 002/03 003/04 005/06 007/ 19 2 20 2 2 20 2 20 2 20 Year

The OPR then measures operators’ performance in (a) producing Daily Timetables which conform with the Master Timetable, and (b) running actual services in conformity with the Daily Timetable. This “twin track” approach to performance monitoring is designed to encourage operators both to run a punctual service and to give their passengers advance warning if they face unavoidable delays or disruption. Because penalties associated with Unplanned delays and cancellations are assessed at twice the rate as those for Planned delays and cancellations, franchisees are incentivised to plan for any disruptions to services and notify passengers in advance.

Calculating incentives and penalties:

Planned and Unplanned Performance, measured in PWMs, are compared to the established targets each month. This produces a net monthly figure for “OPR passenger-weighted minutes”, which is then translated into a dollar figure on the basis of a set financial value (specified in the Franchise

9 The targets shown are notional. In practice, these are likely to change as a result of, for example, additional services run or changes to journey times. PTC initial “target” reflects actual performance.

Department of Infrastructure 57 Agreement) for each PWM the operator registers in excess of or below its target. A PWM is worth approximately $0.28 for metropolitan train services and $0.17 for tram services, and the rates are indexed annually for inflation.

Master Daily Actual Service Timetable Timetable Times

Planned PWM Unplanned PWM

Less Target PWM Less Target PWM

= Incentive/Penalty =Incentive/Penalty PWM PWM

xcentsperPWM xcentsperPWM

+ + - $ - $

Mitigation:

Certain types of services and instances of disruption are excluded from the OPR bonus and penalty regime. Franchisees can request the State to mitigate the effects of these, including:

• force majeure events – exceptional, rare and unforeseen events which have severe impacts (eg, major terrorist actions, natural catastrophes);

• Defined Events – a limited number of events which cause disruption to train or tram services but over which a franchisee has no control (eg, suicides, fires, traffic accidents);

• State Rail Projects – maintenance or construction activity on the network which has been initiated by Government; and

• special events services – Planned “knock-on” effects to normal timetabled services resulting from operation of additional services to support major events (such as sporting fixtures). Note that the extra services themselves are not monitored for OPR purposes.

Other adjustments

The Franchise Agreements set out procedures whereby performance targets may be adjusted to reflect changes in service patterns over time. Every time a timetable change occurs, targets are adjusted to reflect changes in vehicle kilometres operated, scheduled journey times, changes to routes and any alterations to systems which are nominated by the State. In addition, every year , performance targets are tightened to reflect a requirement for continuous improvement in service delivery, and every three years a reset of passenger weightings is carried out to reflect changes in utilisation of services.

4.2.2 Service Growth Incentive regime

The Service Growth Incentive (SGI) was introduced as part of the new franchising arrangements to reward franchisees financially for implementing improvements to the frequency of their services. The SGI tariffs per train and tram kilometre have been set by the State on the basis of the estimated marginal cost to franchisees of providing extra timetabled services. There are separate SGI rates for services run during peak and off-peak periods. These marginal costs are based on the use of existing infrastructure and existing vehicles: that is, they do not contain a capital component.

Department of Infrastructure 58 SGI payments are available only for service enhancements which are in excess of the service levels at franchise commencement and for services proposed by franchisees which are subsequently approved by the State. Service improvements initiated to remedy load standard breaches are eligible for SGI payments; however, increases in service required in response to a State-initiated PSR change are not (these will be compensated through the Franchise Sum Adjustments regime described in Section 4.8.2).

An annual cap is imposed on SGI payments of $3 million per annum for the train franchisee and $4 million per annum for the tram franchisee.

4.2.3 Service Quality Incentive regime

Under the new Service Quality Incentive (SQI) regime, the State can offer franchisees modest discretionary bonuses (eg, up to around $2-3 million per franchise per annum) for the achievement of performance targets and key performance indicators in areas specified by the State following consultation with franchisees. The SQI regime is completely at the State’s discretion, and represents only “upside” for the franchisees. The regime provides the State with an ability to incentivise performance in areas which may be topical or which the State wishes franchisees to work harder on (eg, ticket checking rates, cleanliness, additional customer information).

4.3 Risk and financial management

4.3.1 Farebox revenue risk sharing

As discussed previously, the guiding philosophy behind Partnerships Victoria is that risk in public- private partnerships should generally be allocated to the party best able to manage it. In the case of public transport, neither the Government nor the franchisees are uniquely able to manage farebox revenue risk. A sharing of the risk represents the most cost-effective solution for both parties.

Over the long term at least, patronage and farebox revenue on public transport are affected by exogenous factors beyond the control of franchisees, such as macroeconomic growth and road traffic congestion. Franchisees’ ability to respond through changes in fares or service levels (quantity or quality) are heavily constrained under their Franchise Agreements, and they may therefore be limited in their ability to respond effectively to financial shocks.

At the same time, it is important not to reduce franchisees’ motivation to seek increases in patronage and revenue. The Government is keen to see public transport usage increase, and wishes franchisees to be similarly focused on growing patronage and to have a substantial financial interest in achieving it. With these considerations in mind, the new arrangements include a farebox revenue risk-sharing mechanism whereby franchisees will be offered a measure of “downside” protection.

Any payments under the risk-sharing mechanism are calculated at the end of each financial year (or franchise end), when farebox revenue can be accurately determined. The payment mechanism is triggered when the farebox revenue falls below a threshold level specified in the Franchise Agreement.

The 40/40/20 split of farebox revenue between train, tram and bus (see Section 2.3.7) represents a much higher exposure to farebox revenue risk for the tram operator than the train operator, as it results in the tram operator (a smaller business) receiving a proportionately greater share of its income from the farebox (as opposed to Government payments). The tram franchisee is therefore more at risk from fluctuations in farebox revenue. For this reason the revenue risk-sharing mechanism is calibrated differently for train and tram, providing a more robust safety net for the tram operator:

• Train:

Once triggered, the State will pay 50% of the shortfall between the actual farebox revenue for the financial year and the threshold amount. The risk-sharing mechanism is applied independently for each year.

Department of Infrastructure 59 • Tram:

Once triggered, the State will pay 75% of the shortfall between the actual farebox revenue for the financial year and the threshold amount. The safety net for the tram franchisee is triggered earlier (ie, at a less severe drop in revenue) than for train, and the State pays a higher proportion of lost revenue to the tram franchisee.

In addition, the risk-sharing mechanism for the tram operator is applied on a cumulative annual basis. This means that if a particularly bad year, where the mechanism is triggered and the State makes a payment to the franchisee, is followed by a year sufficiently good to lead to an average farebox revenue above the threshold, then the franchisee will have to repay money to the State. This provides a smoothing mechanism over the life of the franchise.

The Yarra Trams and Connex risk-sharing mechanisms are represented graphically below.10

Train Farebox Revenue Risk-Sharing Mechanism 200

) 195 Equivalent to 190 40% of forecast EBITDA 185 } Forecast 180 revenue 175 Threshold State covers 50% of revenue 170 shortfall in this area

Farebox Revenue ($m 165

160 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 Year

Tram Farebox Revenue Risk-Sharing Mechanism 200

) 195 Equivalent to 190 20% of forecast EBITDA 185 } Forecast revenue 180 State covers 75% of revenue 175 Threshold shortfall in this area 170

Farebox Revenue ($m 165 160 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 Year

10 Note: • The first “year” of the franchise period has been omitted for clarity (it is only 2½ months long). Likewise, the lower figures for the final year reflect the shorter period. • The minor differences between Connex and Yarra’s forecast revenues are the result different assumptions about Concession Top-up payments. • EBITDA is described in Section 4.3.2 on the next page.

Department of Infrastructure 60 4.3.2 Profit sharing mechanism

The Government considers that efficient franchisees should earn a return which is commensurate with the risks they bear. It is clear, however, that it would be unacceptable for franchisees to earn excessive returns from the operation of publicly owned public transport assets, particularly in circumstances where the State is sharing a significant part of revenue downside risk, and where operation was won as a result of single-source negotiations.

The Franchise Agreement therefore contains a profit sharing mechanism, which enables the State to participate in any returns in excess of defined thresholds. The mechanism is based on defined, adjusted Earnings Before Interest, Tax, Depreciation and Amortisation (Adjusted EBITDA). Adjusted EBITDA is calculated on the following basis:

• after adjusting for items that have no associated cash flow effect (eg, movements in provisions, abnormal items); and

• after taking into account franchise payments, risk-sharing payments and Service Growth Incentive payments, but not OPR or SQI to avoid undermining the incentive regimes.

The State will share in excess profits according to the following table:

Profit Sharing Thresholds % Shared by the State Actual Adjusted EBITDA is less than 125% of 0% forecast Adjusted EBITDA for the relevant period Actual Adjusted EBITDA is between 125% and 175% of forecast Adjusted EBITDA for the 50% of the excess returns above 125% will be relevant period shared Actual Adjusted EBITDA is greater than 175% of 50% of the excess returns between the 125% and forecast Adjusted EBITDA 175% threshold and 75% of the excess returns above the 175% threshold

As with the farebox revenue risk-sharing mechanism, profit sharing payments are calculated on an independent annual basis for Connex, but a cumulative annual basis for Yarra Trams, to provide greater overall certainty in Yarra’s environment of higher revenue risk.

The graph below shows the operation of the profit sharing mechanism. The dollar amounts are based on Yarra Trams’ forecasts, but the principle is identical for Connex.

Profit Sharing Thresholds

Franchisee - 25% 20 State - 75%

Franchisee - 50% 15 State - 50% 17 5 % t h r e s h o l d

10 12 5 % t h r e s h o l d Franchisee - 100% State - 0% Forecast Adjusted 5 EBITDA Real Adjusted EBITDA ($m) 0 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 Year

Department of Infrastructure 61 Protections for the State:

Because franchisees’ accounting practices could in theory make collection of profit sharing payments difficult, Adjusted EBITDA was chosen as it represents a “close to cash” profit figure, and which cannot easily be manipulated.

In addition, the mechanism includes a number of other protective measures for the State, including:

• a defined approach to the accounting policies to be used for profit sharing mechanism reporting, and a right for the State to further prescribe accounting policies, with calculations being subject to independent review and penalties imposed for mis-statement;

• an overall “substance over form” test and a general anti-avoidance clause in favour of the State. This includes certain restrictions on transactions with affiliates and employees which are not carried out on an arm’s-length basis; and

• the right for the State to dispute the calculation and refer it to an independent expert for binding resolution.

Any amount payable to the State can be offset against the Franchise Payment, and is also recoverable against the franchisee’s Performance Bond.

Connex arrangements:

Because of the complexity of the Connex structure (with three separate Franchise Entities), the profit sharing arrangements are extended to the profits of MainCo and AMTL. This is designed to prevent entities within the Connex structure transferring profits between companies in order to minimise payments to the State. For the purposes of the profit sharing mechanism, the profits of the Connex, MainCo and AMTL entities are aggregated (on a consolidated basis) and a profit sharing payment is then made by the franchisee if total profits exceed the forecast total profit thresholds. The Connex franchise structure arrangements provide for the cost of this payment to be distributed across Connex, MainCo and AMTL in proportion to each entity’s contribution to overall profit.

4.3.3 Financial arrangements

The Franchise Agreement includes a requirement for each franchisee to provide a Performance Bond to the State guaranteeing the performance of its obligations under the franchising contracts. The bond also underwrites the performance of Metlink, although the extent to which the bond underwrites Metlink is capped.

At the start of the franchise, each franchisee is required to have total shareholders funds in excess of a defined Initial Equity Amount. If, at any stage over the franchise term, total shareholders funds fall below:

• the Initial Equity Amount, then no distributions to shareholders (broadly defined to include dividends, interest and managements fees) are permitted; and

• the Minimum Shareholders Funds Amount, then the franchisee will be required to provide additional funds to ensure it continues to meet the Minimum Shareholders Funds Amount requirement.

These requirements are designed to ensure that each franchisee can accommodate any short term deterioration in its financial performance.

In addition, to ensure the financial arrangements are robust enough to protect against any member of the Connex consortium becoming insolvent, separate Initial Equity Amounts and Minimum Shareholders Funds Amounts for each Franchise Entity are set out in the Connex Franchise Agreement. If the total shareholders funds of an entity falls below its Minimum Shareholders Funds Amount, the other entities are restricted from making distributions until the breaching entity tops up its shareholders funds to the minimum level.

Department of Infrastructure 62 The levels of Performance Bond and the Initial Equity and Shareholders Funds required of the franchisees at the start of the franchise period are shown in the table below:

Minimum Shareholders Performance Bond Initial Equity Amount Funds Amount Yarra Trams $35 million $20 million $15 million Connex $65 million - Connex $30 million $20 million - MainCo $16.2 million $10 million - AMTL $3.5 million $2 million

The amounts specified above are subject to annual indexation in line with increases in the CPI.

In addition, Alstom has provided a bond of $34.5 million to Connex to support the performance of its obligations in respect of its contracts with Connex.

4.3.4 Insurance

The Refranchising Process took place in an environment in which insurance premiums and deductibles had risen substantially following the collapse of HIH, the terrorist attacks in America and a series of rail accidents in Australia and overseas. The Government’s objectives in developing the insurance provisions of the Partnerships Agreements included:

• ensuring that rail assets and services were adequately insured at all times;

• securing value for money and, in particular, ensuring that the industry’s funding requirements were not unduly inflated by franchisees’ inability to forecast future movements in insurance premiums or deductibles; and

• ensuring that the existence of multiple operators and different insurance policies within the rail industry did not create disputation or delays in settling claims if an accident occurred.

After careful consideration, it was decided that insurance responsibilities and risks would be shared between the State and the franchisees in order to provide the most efficient and best value outcome. Under the Franchise Agreement, above specified deductible limits, the State is responsible for securing, funding and holding insurance cover in relation to:

• infrastructure assets;

• rolling stock; and

• public liability.

If a claim is made under the State-procured insurance policies, the relevant franchisee is responsible for paying the deductible. Franchisees effectively “self-insure” for this deductible risk through their cash flows. The State has powers to alter the deductibles defined in the Franchise Agreement but must compensate the franchisees if their deductibles are increased.

The deductibles for which the franchisees are responsible are:

Train Tram Infrastructure $2.0 million $0.5 million Rolling stock $5.0 million $0.5 million Public liability $0.1 million $0.1 million

Franchisees take responsibility for securing and funding insurance for workers’ compensation and motor vehicle liability.

Department of Infrastructure 63 4.3.5 Employee entitlements

Under the 1999 franchising arrangements, the financial liabilities associated with employee entitlements (principally annual leave, accrued sick leave and long service leave) were assumed by the franchisees at the commencement of the franchise period. The franchisees were then required to pay the balance of employee entitlements to the successor operators at the end of the franchise term. With the departure of National Express, and the subsequent State guarantee of entitlements to employees of National Express’s franchises, it became obvious that the concept of fully transferring this risk to the private sector was flawed.

If continued in the new Partnership Agreements, this obligation on franchisees to assume employee entitlement liabilities would have increased the cash cost to the State (for no obvious benefit), and exposed the State to the risk of having to guarantee employee entitlements anyway in the event of a franchisee failure. Therefore, new arrangements were put in place which minimised the up-front cost to the State, provided certainty to the State in terms of funding required, and removed any incentive to the franchisees to build up liabilities over the term of the franchise.

Under the new arrangements, the State retains the long term liabilities associated with employee entitlements, while the franchisees and the Franchise Entities are required to honour the entitlements of their employees throughout the term of the Franchise Agreement. In its Offer, each franchisee was required to forecast movements in annual and other leave entitlements (but excluding sick leave and long service leave) during the franchise period. The costs associated with meeting employee entitlements during the franchise term were factored into the franchisee’s base financial projections.

The annual balances and the balance upon termination which were forecast by the franchisee in its Offer were documented in the Franchise Agreement as benchmarks. Each year, the franchisee’s performance against these benchmarks is measured and “true-up” payments are made as follows:

• if the balance of employee entitlements is in excess of the benchmark at 30 June, then the franchisee will make a payment to the State for the excess; and

• if the balance of employee entitlements is below the benchmark, then the State will pay the franchisee the balance.

Payments under this mechanism will be made annually and upon franchise termination.

The mechanism for dealing with long service leave follows similar principles but is based on a “cash” rather than a “provision movement” basis:

• if the actual amount of long service leave paid by the franchisee is in excess of the benchmark, then the State will pay the franchisee the excess; and

• if the actual amount of long service leave paid by the franchisee is less than the benchmark, then the franchisee will pay the State the shortfall.

4.3.6 Superannuation

The franchisees are responsible for the payment of all employer superannuation contributions. Franchise employees who were members of State Superannuation Scheme funds prior to refranchising were entitled to remain in the scheme when transferring to equivalent employment with Yarra Trams and Connex.

4.3.7 Viability Reviews

Having had to confront a major financial crisis in the rail industry over the preceding two years, the Government was keen, in framing the Partnership Agreements, to ensure that it was able to respond flexibly to circumstances in which a franchisee was facing financial difficulties which could compromise its ability to fulfil the conditions or intent of the contracts. In such circumstances, therefore, the Franchise Agreement allows the State to initiate a Viability Review. In addition, the

Department of Infrastructure 64 franchisee may request that the State initiate a Viability Review, but the State will be under no obligation to agree to such a request.

When deciding whether or not to initiate a Viability Review, whether at its own instigation or at the request of the franchisee, the State will generally consider whether the franchisee is likely to incur material financial losses on a continuing basis and whether this has the potential to affect the franchisee’s ability to fulfil its franchise obligations.

If the State decides to initiate a Viability Review, the franchisee must cooperate with all reasonable requests for information and ensure such information is accurate and complete.

On completion of a Viability Review, the State notifies the franchisee what, if any, action it proposes to take to mitigate the franchisee’s financial position, and any conditions attached to such action. Where the State’s proposal involves amendments to the franchise contracts, the franchisee will be required to negotiate in good faith with the State in relation to those amendments.

Where the Viability Review has been undertaken at the request of the franchisee, the State will also have an option to terminate the franchise, and take over operation of the franchise business or retender it. This power ensures that franchisees initiate Viability Reviews only if absolutely necessary.

4.4 Asset management

4.4.1 Infrastructure maintenance and renewals regime

The infrastructure that makes up the rail system is owned by the State (through VicTrack) and leased to the franchisees for the duration of the franchise period. Infrastructure includes track, overhead, signalling, depots, stations, bridges, subways, service roads, Metrol (the central train control facility) and Electrol (the central electrical supply facility). The Government has a strong interest in ensuring that franchisees maintain these assets properly, considering not just the short term but the long term condition and integrity of the network.

Vertical integration of the rail franchises provides many benefits, particularly in relation to prevention of blame-passing when delays or accidents occur. However, rail assets tend to have extremely long effective lives (over 50 years for a large proportion of assets). For this reason, there are few intrinsic incentives for franchisees to maintain and renew infrastructure to a high standard when they are custodians for only a short time. Five-year franchises further increased the importance of an adequate oversight regime. Without adequate safeguards, franchisees could run their networks safely for five years while spending only minimal amounts on infrastructure maintenance and renewal, by building up a backlog of maintenance work for the future. Clearly this was undesirable, and in the absence of commercial incentives on franchisees to perform high-quality infrastructure maintenance, contractual safeguards were necessary.

Previous regime:

Under the original Infrastructure Lease, franchisees were required to undertake infrastructure works so as to maintain the infrastructure’s long term condition, and the State had the right to monitor the infrastructure to ensure it was not deteriorating. It was therefore an output-based regime, allowing franchisees a great deal of flexibility in undertaking their maintenance and renewals.

The condition of the infrastructure across the train and tram networks was measured in initial surveys immediately prior to franchising in 1999. Infrastructure was split into classes and types, and every item of infrastructure was assessed according to an agreed methodology to arrive at an overall “condition index” figure. The survey was to be repeated on a sample of the network every three years to monitor franchisee performance by comparing the condition index scores.

As a form of “input-based protection” to ensure the franchisees did spend money on infrastructure maintenance and renewal, part of their base contract payment was paid into an escrow account and could only be drawn down for spending on infrastructure works. The franchisees provided Asset Management Plans to the State which documented their intended works programs.

Department of Infrastructure 65 If the three-yearly condition index assessments showed a franchisee’s infrastructure was deteriorating, the franchisee had to increase expenditure on maintenance and renewal works. Conversely, if it was ahead of its condition requirements, the franchisee retained any financial surplus. In this way the franchisees took all the risk associated with infrastructure maintenance.

Unfortunately, in practice the innovative output-based regime did not work:

• the survey methodology was subjective and partial, with assessment open to high levels of subjectivity. This made it difficult to replicate the initial survey with sufficient reliability. Together with the small sample size of the three-yearly assessments, the survey was estimated to be accurate only to plus/minus 10% – a huge level of uncertainty for a $240 million per annum investment;

• the initial (pre-franchising) survey was found to be inadequate and based on faulty assumptions (eg, incorrect asset life cycles). In addition, it measured only the whole train network and whole tram network, meaning that the actions of one operator could affect the other;

• the methodology was extremely complicated, making it hard for all parties to understand and leaving it open to “gaming” by franchisees (eg, spending in areas which would maximise condition index benefits rather than be the most appropriate for renewal); and

• the status of the network at any point in time between the three-yearly surveys was unknown, making it impossible for franchisees to tell how they were going in terms of infrastructure maintenance and renewal.

These methodological problems were identified relatively early in the original franchises, and the IOAs acknowledged that the scheduled 2002 condition index surveys would not be undertaken. There was no evidence of under-maintenance by the franchisees, and in fact all claimed to have “front-end loaded” their maintenance and renewal works during the early years of their franchises in order to gain the benefits for the longest possible time. Nevertheless, this regime did not represent a reliable contractual basis for moving forward, and the condition index regime was scrapped in favour of a more input-based regime for the new franchises.

The new regime:

Asset Management Plans

In developing a new infrastructure condition regime, the State sought to communicate to the franchisees its objectives for the long term maintenance and renewal of infrastructure and to ensure that the franchisees’ plans matched these objectives as part of a practical, cost-effective and objectively measurable regime.

Under the resulting input-based regime, infrastructure maintenance and renewal is based on the franchisees’ Asset Management Plans. As part of its Offer for the franchise, each franchisee provided an Asset Management Plan (AMP) covering the whole franchise period. Each AMP was developed in discussion with PTD and in line with the principles set out by the State in the Guidance Material document provided to franchisees during the Refranchising Process (see Section 2.6.4). This was done in such a way as to ensure the State’s objectives were achieved, with all risks associated with the cost, works quality, effectiveness and operational impact remaining with the franchisee.

The AMPs set out the infrastructure maintenance and renewal activities the franchisees will undertake during the franchise period to ensure the safety, reliability and integrity of the infrastructure. Each AMP sets out:

• organisational structure, key appointments, resourcing and skills retention, including proposed contractor (or sub-contractor) arrangements;

• a routine maintenance program and physical scope of works, specifying what activities will be undertaken. This includes works needed to meet the minimum levels agreed during the

Department of Infrastructure 66 Refranchising Process and to ensure the requirements under the Infrastructure Lease are met;

• the inspection regime for each asset type, including frequency and relevant standards where appropriate;

• performance standards for reactive works, and the response times required;

• pre-agreed quantities of asset renewal;

• the resource requirements, timing and costing for each element of works activity;

• a quality assurance plan;

• works methods plans showing how activities will be undertaken; and

• references to industry standards.

Under the terms of the Infrastructure Lease, the franchisees must undertake the activities set out in their AMPs. This is the basis of the new maintenance and renewal regime. The AMPs therefore give the State confidence that the value of its assets is being protected, and that over the long term the rail network will continue to be able to meet the standards required of it.

The allocation of risk in the old and new regimes is summarised in the table below:

Previous New Risk Arrangements Arrangements Infrastructure works delivery (price and quality) Franchisee Franchisee Operational performance of infrastructure Franchisee Franchisee Long term asset condition Franchisee State

The State is now taking the risk of long term asset condition – ie, the risk that the works set out in the AMPs will not prevent the infrastructure from deteriorating over time.

Annual Works Plans

The AMPs set out at a high level what the franchisees will do to maintain the infrastructure, including quantities of works (eg, number of sleepers to be replaced each year, number of station platforms to be rehabilitated). The AMPs cover the whole franchise period.

Every year, each franchisee provides an Annual Works Plan (AWP) which details the specific works to be undertaken that year (eg, the specific times, locations, resources and work plans for the resleepering and platform rehabilitations).

Escrow regime and contract enforcement

Under the original franchises, a portion of each Franchise Payment was placed in an escrow account and then transferred to the franchisees’ maintenance accounts each month to be drawn down for maintenance and renewal spending. The franchisees had to substantiate this spending each quarter, but in practice it was sometimes difficult for PTD to confirm whether money actually had been spent on infrastructure works or not.

The new arrangements are designed to address this difficulty while ensuring money is available for maintenance and renewal activities. Claims on the escrow account are made through the submission of an invoice to PTD at the end of each month for works set out in the AWP, along with any supporting material required to demonstrate the legitimacy of the claim. PTD then transfers money into the franchisee’s account for direct costs of works only (not corporate overheads), up to a maximum amount each month. Since AMP works are binding on the franchisee, any cost overruns (ie, if the AWP costs more than is available in the escrow account) must be met by the franchisee. However, in order to reduce the opportunity for franchisees to save money by reducing the quality of

Department of Infrastructure 67 infrastructure works, any surplus funds left in the escrow account at the end of the franchise period will return to the State.11

The Infrastructure Lease mandates specific materials for individual activities to ensure high quality works that will make sure assets achieve their full expected life. To ensure works are being carried out to appropriate standards and quality, the State audits the maintenance and renewal activities and can withhold payment if works are not delivered to the required standard. Franchisees have obligations in relation to data provision and reporting, including maintenance of an “open book” regime and integration of their internal information systems with those of PTD. All of this is designed to ensure the Government has the most accurate and detailed information possible about its assets, even though asset management is being undertaken by the franchisees.

As an additional safeguard, 5% of the value of all monthly invoices presented by each franchisee to PTD is retained in the escrow account. This retained amount is released on a quarterly basis to the franchisee provided that the monitoring, auditing and review process shows to PTD’s satisfaction that the franchisee has complied with its maintenance and renewal obligations under the Infrastructure Lease.

Key Performance Indicators

To provide further information to the State on the condition of infrastructure and the quality of maintenance and renewal activities, the list of Key Performance Indicators (KPIs) in the Infrastructure Lease was significantly expanded. The franchisees now have to provide quarterly information on a large number of Functional KPIs (those relating to infrastructure performance), Asset Condition KPIs (those relating to the condition of the assets) and Maintenance Effectiveness KPIs (those relating to the effectiveness of the franchisee’s maintenance and renewal effort). These reports provide early warning to the State if asset condition is deteriorating or safety is being compromised.

Removal of separate Non-Core Infrastructure Leases

Under the original franchising arrangements, the Infrastructure Leases were supplemented by Non- Core Infrastructure Leases (NCILs) for assets which were not absolutely integral to the infrastructure network and which had a high alternative use value (principally depots and maintenance facilities). Franchisees paid market rental rates for these properties, which was designed to incentivise them to look for opportunities to amalgamate or otherwise rationalise their stabling and maintenance facilities. However, as assets under the NCILs were not covered by the maintenance and renewal regime or the escrow arrangements, the franchisees, faced with finding additional money for renewal of non-core assets, undertook only emergency maintenance, and the quality of the train and tram depots deteriorated.

The State was keen to see the non-core assets maintained to a level commensurate with its objectives for the core infrastructure, and to ensure that any projects undertaken on non-core infrastructure were carried out under the new project delivery mechanisms. For this reason, non- core assets were brought under the auspices of the Infrastructure Lease, and the NCILs (and the distinction they implied) abandoned.

Nevertheless, depots and maintenance facilities continue to be leased at market rental rates. No depot rationalisations took place during the three years of the first franchise arrangements, and none are likely given the short payback period of the new five-year franchises. However, the rent payments have become an important income stream for VicTrack and so it was decided to retain them at commercial rates rather than reduce them to a nominal figure.

Commitments to specific depot enhancements and a review of the future of Newport Depot are also included in the franchising arrangements.

11 In the event of surplus money, it is likely this would be invested by the State in further infrastructure improvements.

Department of Infrastructure 68 4.4.2 Asset improvement regime

In addition to maintenance and renewal activities, the Government wishes to see cost-effective improvements to infrastructure over time – particularly given the increased role expected of the rail system in the future. An asset improvement regime was therefore developed to allow the franchisees to propose small to medium sized improvements ($100,000 to $5 million) aimed at overcoming safety and operational constraints and improving the performance of the existing network. The regime allows for the development and funding of projects that have demonstrable benefits but would not otherwise be undertaken by the franchisees because commercial payback periods would extend beyond the franchise period. Examples include additional crossovers, upgrade of substations, removal of redundant station buildings, signalling improvements and automated points.

Each franchisee must provide a list of Asset Improvement Projects to PTD each year, providing a high level description of the works and the expected costs and benefits. PTD will then identify the proposals it considers warrant further development. If PTD decides that it wishes to implement a project, the franchisee will be required to prepare a more comprehensive business case for use in funding applications. PTD can also propose its own projects.

The State is under no obligation to fund any proposals it receives. It will choose which projects to fund, if any, on the basis of its assessment of their expected net benefits, and the State’s broader economic, social and fiscal considerations. Once approved, the franchisee will be required to undertake the project as a Franchisee Project (see Section 4.6.6). The State will pay the franchisee an agreed amount for the project through milestone payments or through a lump sum on completion, depending on the nature of the project.

4.4.3 Asset control

Infrastructure database:

A number of difficulties arose during the initial franchise period as a result of the lack of a complete and up-to-date database of infrastructure engineering data.

To address these difficulties, PTD developed the “PASS Assets” system around the end of 2003, to provide a database of:

• data that describes the characteristics, configuration and developmental history of an asset;

• standards and specifications that describe how such assets are to be designed, constructed and maintained; and

• infrastructure engineering design, construction and maintenance standards and specifications.

This infrastructure database is a central and enduring repository of information, of which the State is the custodian and controller. However, to assist the rail industry to manage infrastructure effectively, franchisees are able to access data relevant to their Infrastructure Lease. Since franchisees will maintain and renew infrastructure, they are required to provide the State with information relating to works undertaken on the infrastructure to enable the database to be kept up to date.

The success of this database is likely to depend on the ability of the State and franchisees to work in partnership and to cooperate in the maintenance of the database. To maximise the chances of success, the Infrastructure Leases require the franchisees to:

• provide the State with current versions of any engineering data which they hold (eg, asset configuration information and related databases, design, construction and maintenance standards and specifications, and drawings);

• establish their own connection to the electronic systems managed by the State and provide the hardware to read and print accessed information;

Department of Infrastructure 69 • regularly and promptly inform the State of any changes made to the infrastructure (in particular, works undertaken which affect asset configuration) and engineering data;

• provide data in electronic form that is compatible with the industry standard of the systems and which enables the State to maintain up-to-date systems; and

• submit to the State applications for any material change to the engineering data. Where the change will impact the interoperability of operations on the Victorian rail network, the application must include agreement to the change of the other Victorian rail infrastructure managers.

Intellectual property:

“Intellectual property” covers all the patents, copyrights, trademarks and other privileged technical and commercial information associated with the operation of the train and tram networks. The Franchise Agreement confers on the franchisee, for the term of the franchise, a royalty-free licence to use the intellectual property needed to operate the leased assets. However, it also ensures that all intellectual property rights (including those which relate to technical improvements to systems and assets undertaken by the franchisee) revert to the State when the Infrastructure Lease expires. This ensures that any successor operator has all the information it requires in order to operate the network.

Asset register:

While a database of major rail assets is maintained by the State with the support of franchisees, the franchisees are required under the Franchise Agreement to maintain an up-to-date register of assets that are not part of the fixed rail infrastructure. Such assets include plant and equipment, inventory and rotables (fleet inventory). The franchisees must provide updated registers to the State every six months, in a form set out in a Practice Note. This allows both the State and the franchisees to monitor the level, condition and value of assets in the rail businesses, and provides warning in the event that, for example, spares are running low. It also provides clarity around the details and price of assets to be transferred to a successor operator at the end of the franchise period.

4.4.4 Latent defects

Latent defects are structural defects in buildings, tunnels or bridges on the leased land that existed at the beginning of the franchise period, and which the franchisee was not aware of (and could not reasonably have foreseen) and did not contribute to. On the tram network, latent defects also include defects in the track or track sub-structure (as the franchisee is less likely to be aware of these on the tram network because the track structure is generally not visible).12

Franchisees are responsible for funding rectifications to latent defects below a threshold amount. The threshold amounts under the old and new Infrastructure Leases are set out below:

Original New Arrangements Arrangements Train $7.0 million $3.5 million Tram $3.5 million $3.5 million

The threshold ensures that the franchisees do not seek compensation from the State for a large number of relatively minor issues. However, an excessively high threshold value would have encouraged franchisees to price the risk associated with latent defects into their Offers, increasing the funding required from the State. The train threshold was therefore reduced from the previous level to reduce the risk to the train franchisee (and thereby the cost to the State).

12 This only applies on the part of the tram network previously operated by M>Tram. Yarra Trams cannot claim that defects in the track or track sub-structure are latent defects if they occur on part of the network that Yarra Trams previously operated – it is expected to know about issues on the part of the network for which it was previously responsible.

Department of Infrastructure 70 4.4.5 Disability Discrimination Act compliance

Under the terms of the Commonwealth Disability Discrimination Act (DDA), public transport infrastructure must be made accessible to people with disabilities according to a timetable set out in the Disability Standards for Accessible Public Transport. These “Transport Standards” were approved by the Federal Government in October 2002, and must be achieved progressively broadly as specified below:

• 25% compliance by 2007;

• 55% compliance by 2012;

• 90% compliance by 2017; and

• 100% compliance by 2022, except for rolling stock (by 2032).

Under the DDA, public transport operators are responsible for ensuring compliance with the Transport Standards, and this overarching principle was reflected in the Franchise Agreement. Under the Franchise Agreement, each franchisee must meet the 2007 milestone, and work towards achieving the 2012 milestone on a pro rata basis (as this milestone will not fall during the current franchise period). To ensure the franchisees have coherent plans for achieving these obligations, each franchisee was required to submit an Action Plan to the State and to the Human Rights and Equal Opportunities Commission (HREOC). The Action Plan covers the whole of the franchise period and outlines a plan of major works to comply with the requirements of the Transport Standards, including indicative timing and costings, showing how works will be targeted to maximise the benefit for money spent.

However, it is likely to be very difficult to achieve compliance with some parts of the Transport Standards, particularly on the tram network. Provision was therefore made in the Franchise Agreement for the State to work with franchisees to develop solutions and fund works in certain areas of compliance, such as the gradient of access ramps on the train network.

Ensuring compliance on the tram network is significantly more challenging than on the train system, for a number of reasons:

• responsibility for compliance in some areas does not lie with the tram operator or is not clear (eg, at kerbside stops);

• responsibility for compliance in some areas does lie with the tram operator, but compliance requires the support of other parties (eg, at safety zones);

• compliance in some areas could be expensive compared to other non-capital options, particularly when multiplied by the large number of tram stops (eg, tram boarding).

The Franchise Agreement requires works to continue, with a view to achieving full compliance over time, but without exposing the tram operator to a large risk over which it has little control. The Franchise Agreement includes a large number of exceptions to the compliance milestones, on which the State and Yarra Trams must work together to agree a way forward and include in the Franchisee’s Action Plan for submission to HREOC.

Notwithstanding this, Yarra Trams is required under the Franchise Agreement to achieve full compliance with the Transport Standards at 35 to 40 stops. These are stops which are relatively easy and inexpensive to make compliant, and which are on routes served by low-floor trams.

Every year, each franchisee must:

• provide a report outlining progress over the last year in implementing DDA works;

• undertake an audit of compliance across the tram network and provide details to PTD; and

Department of Infrastructure 71 • provide a DDA Milestone Plan outlining works over the next three years for meeting the milestones under the Franchisee’s Action Plan.

Tram exemption:

Victoria was granted a temporary exemption by HREOC from the Transport Standards relating to tram rolling stock and physical access to trams. This exemption expired in March 2004, and Yarra Trams sought comfort from the State that this exemption would be renewed. Since the introduction of the Transport Standards, there is no “non-compliance” issue until the first milestone in 2007. However, in the event that a further exemption is needed and the State is unsuccessful in an application for a renewal of the exemption, it will have the right to terminate the Yarra Trams franchise. This provision is designed to protect the franchisee from the potentially massive costs associated with a requirement to meet the Transport Standards milestones in relation to tram boarding.

Pedestrian crossing standards:

As part of the Infrastructure Lease, new broad standards were introduced for train and light rail level crossings to improve safety for pedestrians, particularly wheelchair users. Franchisees are required to:

• upgrade 150 train and eight light rail pedestrian rail crossings in line with the new standards, at a specified minimum annual rate;

• develop and implement improved pedestrian crossing maintenance and disability access monitoring systems; and

• ensure that all supervisory and infrastructure maintenance staff and contractors receive training:

o in any new pedestrian crossing design and maintenance standards; and

o to familiarise them with the needs of disabled crossing users.

4.4.6 System upkeep regime

System upkeep encompasses the broad customer service areas of graffiti control, cleanliness of rolling stock and infrastructure, removal of litter and other rubbish, and the provision of information. It was recognised that this was an area where performance was sub-optimal in the original franchises, and an improved regime was designed during the Refranchising Process. The new regime retained the old arrangements as a basis, but tightened up in areas where the franchisees were seen to have performed poorly (as represented by passenger, local government and other stakeholder complaints to operators and the Government). Accordingly, the focus was mainly on graffiti and litter removal provisions.

Despite being concerned with infrastructure, the system upkeep regime was retained in the Franchise Agreement as cleanliness of stations and rolling stock is seen as a customer service issue, rather than an infrastructure management issue. Whereas under the original arrangements the focus was on compliance with set directives, under the new regime compliance and monitoring also focus on franchisees’ processes for achieving minimum standards.

Franchisees are required to produce annual System Upkeep Plans, detailing the processes they have put in place to manage graffiti, cleanliness, litter and information provision to ensure the minimum standards in the Franchise Agreement are met or exceeded. The System Upkeep Plans ensure the franchisees have well thought-out and robust plans for managing system upkeep and provide insight for the State into the possible reasons for any failure to meet the minimum standards. The provisions of the System Upkeep Plans are enforceable under the Franchise Agreement.

The system upkeep regime includes:

Department of Infrastructure 72 • removal of graffiti on rolling stock and in publicly accessible areas around stations and stops within 24 hours of reporting or three days of occurrence – the previous regime required removal within 24 hours of reporting only, which led to problems enforcing the requirement when franchisees claimed graffiti had not been reported. Franchisees’ System Upkeep Plans clearly document the arrangements they have in place to ensure the three day obligation is met;

• longer removal times for graffiti at smaller tram stops (where an intensive monitoring regime would not be cost effective) and for offensive graffiti in non-accessible parts of the train network (where access may be restricted, difficult or dangerous). For cost reasons, Connex is not required to remove graffiti from non-publicly accessible parts of the train network unless it is offensive;

• obligations on franchisees to clean and remove graffiti from ticketing equipment where this occurs on the non-sensitive parts of the equipment. OneLink is responsible for cleaning and graffiti removal on sensitive areas of the ticketing equipment, ensuring that the risk of damage to equipment from cleaning activities remains with OneLink (since they carry performance risk) and minimising the potential for OneLink/franchisee disputes;

• cleaning of rolling stock every day (twice a day for trams), with periodic major internal and external cleans;

• repair of vandalism damage as soon as reasonably practicable;

• removal of litter at stations and major tram stops, and emptying of rubbish bins, every day. Removal of dumped rubbish on the leased land for the tram franchisee, including rubbish which has a significant adverse impact on the visual amenity of nearby residents; and

• obligations to provide accurate and up-to-date service information at all stations and stops.

4.4.7 Vegetation management regime

Vegetation management (activities to ensure vegetation on the leased land is kept safe and under control by franchisees) was handled in a similar way to system upkeep. Under the previous Infrastructure Lease the franchisees were simply required to control vegetation which was a fire risk or which presented an operational hazard. The new arrangements sought to address the limitations of this approach, in particular to:

• encourage a more proactive approach to vegetation management;

• address impacts on the safety or property of persons on the leased land or adjoining land;

• address impacts on the visual amenity of nearby residents (eg, where vegetation was not kept under control and became a significant eyesore);

• comply with new laws on fire prevention and preparedness; and

• prevent “scorched earth” solutions to vegetation management where flora was removed, rather than pruned, in order to save money.

Annual Vegetation Management Plans are required from franchisees to detail the processes that are in place to ensure the new minimum standards are achieved.

4.4.8 Environmental management regime

As owner of railway land, VicTrack was the driving force behind the development of more specific environmental obligations on the franchisees.

Each franchisee is required to provide an annual Environmental Management Plan, which documents the franchisee’s processes for managing pollution and other environmental impacts on its leased land and ensures it has appropriate policies, controls and procedures in place to manage

Department of Infrastructure 73 environmental issues, including emergencies. The Environmental Management Plan also details how the franchisee will meet the Infrastructure Lease requirements to comply with relevant environmental laws.

4.4.9 Information technology and communications

The original franchise contracts were largely silent on the issue of information technology (IT) and communication systems. When National Express withdrew from its franchises, however, and the Government stepped in to take over operations, it became apparent that chronic under-investment in IT had been occurring. Independent audits undertaken by the Government during the Refranchising Process revealed that Yarra Trams and Connex had similarly outdated and unreliable IT equipment and systems, and the results had the potential to affect the operation of their businesses.

Clearly, there were significant risks associated with franchisees not having adequate IT support systems, particularly given the large amount of data, records and reporting the franchisees would be required to handle under the new franchise arrangements. The Government was anxious to ensure that the franchisees had robust IT systems on which to base their franchise operations, systems which were capable of supporting the new franchise arrangements. Also, particularly given the experience with National Express, it was recognised that it was important to ensure IT systems would be capable of continued operation without significant additional investment when the franchise was passed to a successor operator (or the State) at franchise termination.

To achieve these objectives, a number of initiatives were included in the franchise contracts:

• State-funded projects to update franchisee IT systems to provide current, integrated software and management and support systems. Franchisees are required to report against IT plans, and the State has the right to regularly audit franchisee systems to ensure they are up to standard;

• a requirement for each franchisee to maintain currency of, and support for, software and hardware technology within its business throughout the franchise period;

• strengthened licensing and intellectual property rights to ensure systems are available to the State or successor franchisees upon termination of a franchise;

• detailed data and system reporting requirements; and

• a requirement for the franchisees to work with PTD to develop a Public Transport Information Communications Technology Strategy for the Victorian transport sector. This strategy will define a framework for information, communication and technology projects associated with the real-time operation of the network, and set out principles for maximising interoperability among public transport operators.

4.4.10 Closed-circuit television systems

In order to streamline reporting and data handling procedures, the Franchise Agreement requires franchisees to provide closed-circuit television (CCTV) data of incidents to the State and provides for a central Keeper of Evidence within Government, who is responsible for receiving, cataloguing and distributing CCTV data to police or other stakeholders as required. Having a central point provides a comprehensive and efficient system with a clear trail of evidence, minimising the chance of lost data and ensuring that parties who need access to the data (and only such parties) can access it.

The original train Franchise Agreements contained only basic requirements in relation to CCTV on trains and at stations; there were no requirements for tram franchises. However, the Government was concerned that seven-day retention of CCTV images was too short, and in a number of cases images had been taped over by the time an offence came to light.

Because the cost of the upgraded infrastructure required to increase the image retention period on the train network could not be determined with any clarity, this issue was included in the Franchise Agreement as a matter to be addressed, and may form a project for implementation in the future when the scope and cost can be defined in detail. There were no similar problems for Yarra Trams

Department of Infrastructure 74 as there is very little coverage of passenger CCTV on the tram network, and so the costs of complying with the standards would be covered by the cost of any new system (for which the State would be likely to pay anyway).

4.5 Rolling stock

4.5.1 Existing and new rolling stock

The metropolitan rolling stock fleets can be sub-divided into “existing rolling stock” (trains and trams which were purchased before the original franchises were let and were “inherited” by the private sector in 1999) and “new rolling stock” (which has been introduced since 1999). Within these categories, trains and trams are categorised by their builder or manufacturer.

By the start of 2006, the introduction of new Alstom X’trapolis and Siemens Nexas trains will be completed, and old Hitachi vehicles will be retired. The introduction of new Citadis trams was complete at the start of the Partnership Agreements. Combino trams will be fully introduced by the end of 2004, substantially replacing the old Z1 and Z2 Class vehicles.

Train Type April 2004 July 2006 Existing Rolling Stock Hitachi 29 0 (six-carriage trains) Comeng 93 93 New Rolling Stock X’trapolis 16 29 (six-carriage trains) Nexas 19 36 Total 157 158

Tram Type April 2004 Dec 2004 W5353 Z1/2 86 10 Existing Rolling Stock Z3 114 114 A7070 B 132 132 Citadis 36 36 New Rolling Stock Combino 3 38 38 Combino 5 1 21 Total 530 474

4.5.2 Ownership

Although franchisees control and are responsible for maintaining all the vehicles in their respective fleets, they do not own all the vehicles outright.

Existing rolling stock:

Existing rolling stock is largely owned by a State body (Rolling Stock Holdings Victoria – RSHV), which leases it for a nominal consideration to Yarra Trams and Connex for the duration for their franchises. There are some exceptions to this leasing arrangement: Connex continues to own outright the Hitachi trains which it owned under the previous franchise arrangements, and is responsible for disposing of them once they are withdrawn from service. Yarra Trams continues to own the vehicles it owned under its previous franchise and is required to hand them back to the State for a nominal sum at the end of its franchise.

New rolling stock:

New rolling stock is subject to more complex procurement arrangements. The new vehicles were funded by private financial institutions (Commonwealth Bank and Allco), which are required and entitled to lease them to the franchisees (and their successors) for a minimum period of 15 years.

Department of Infrastructure 75 After 15 years, the State has the option to purchase the rolling stock, negotiate to extend the lease for a further period, or procure replacement vehicles (eg, if it is dissatisfied with their performance). Lessors therefore assume the risk that if their new rolling stock proves unreliable or the price of new rolling stock falls significantly, the State may elect to replace the rolling stock midway through its economic life by not exercising its option over the rolling stock at the expiry of the lease. In such circumstances, lessors would be asked to remove their rolling stock and they would then seek to recover their residual value through leasing the vehicles in other markets or through sale.

The construction and delivery of the new rolling stock is managed through Supply Agreements and Maintenance Agreements between the franchisees and the manufacturers. The table below shows the companies involved in owning, supplying, maintaining and operating the new rolling stock:

Nexas Train X’trapolis Train Combino Tram Citadis Tram Alstom SA & Alstom SA & Supplier Siemens Ltd Siemens Ltd AMTL Alstom Australia Maintainer Siemrail Victoria Alstom (AMTL) Siemrail Victoria Alstom Australia Commonwealth Commonwealth Commonwealth Lessor Bank Bank Bank Allco Finance Residual Value Commonwealth Commonwealth Commonwealth Transdev & Guarantor13 Bank Bank Bank Transfield Operator Connex Connex Yarra Trams Yarra Trams

The contractual structure underpinning the new rolling stock delivery arrangements is shown below.

Rolling Stock Maintainer Direct Agreement Maintenance Agreement

Debt Franchisee State Financiers Franchise (Director) Supply Agreement Agreement Lease

Equity Rolling Stock Financiers Lessor Direct (Residual Value Agreement Guarantors) Supply Agreement

Construction Rolling Stock Supplier Financing Direct Agreement

At the commencement of the current franchises, delivery of new Combino trams and Nexas and X’trapolis trains was not complete. The Supply Agreements for these vehicles were left in place with the lessors and National Express. Delivery Assistance Agreements were then executed to transfer the obligations of National Express in respect of the acceptance of the new rolling stock on to Yarra Trams and Connex.

13 This is the ultimate owner of the rolling stock – ie, the party which will be left with the vehicles if the State chooses not to continue to lease them after the current 15-year lease has ended.

Department of Infrastructure 76 Intellectual property:

Generally, the rights to intellectual property of rolling stock is held by the original manufacturer of that rolling stock. In the case of the existing rolling stock, the State has limited access to most intellectual property rights (a legacy of the PTC). The train and tram operators’ access rights to this intellectual property and the State’s obligations in respect of it are set out in the Intellectual Property Management Deed.

Ownership of the intellectual property for new rolling stock also rests with the rolling stock manufacturers. However, these manufacturers are required to grant the State a perpetual, non- revokable licence to use the intellectual property which it is likely to need (eg, to repair damaged vehicles). This is provided free to the State, which has the right to provide this to incumbent and future franchisees.

4.5.3 Rolling stock maintenance

Although the control of the rolling stock fleets rests with the train and tram operators, the State has powers through the Franchise Agreement to ensure that these vehicles are maintained properly. The condition of all trains and trams has been assessed and a “condition index” applied to each type of vehicle. The assessment methodology for rolling stock condition is based on engineering standards and limits specified in the Franchise Agreement, which comprise:

• engineering standards deemed as acceptable for ongoing operation (field service limits);

• standards specified for triggering the retirement or replacement of an item (condemnation limits); and

• limits for determining whether or not an asset is safe (safety limits).

Franchisees are required to ensure that, for each vehicle type, this condition index is at least maintained throughout the franchise.

Under the Franchise Agreement, each franchisee is required to prepare a Rolling Stock Management Plan and an Annual Rolling Stock Maintenance Plan, which are updated on an annual basis. These plans set out the franchisee’s proposed maintenance and renewal strategy for its vehicles and the main elements of its preventative maintenance program, refurbishment program, modification programs and upgrade programs, over the life of each rolling stock type. The franchisee is required to undertake overhauls in line with this documentation.

In order to verify that appropriate preventative maintenance is being performed, the State may audit each franchisee’s maintenance and renewals works while they are being carried out, including works undertaken off-site by sub-contractors. Where these audits identify a failure to meet required standards, the franchisee must undertake remedial works.

When the Franchise Agreement ends, the State will undertake a condition index assessment and a full fleet inspection to ensure that each item of rolling stock is in a serviceable condition (subject to normal fair wear and tear), and is without unrepaired vandalism, accident damage or graffiti. Again, the State has the right to require the franchisee to carry out any necessary remedial work and to meet the costs of undertaking such work.

Franchisees are required to report regularly on their performance in managing the rolling stock fleet. Key performance indicators (KPIs) include:

• availability of rolling stock (ie, the proportion of time each unit is available for operational service);

• planned versus actual maintenance programs;

• the mean distance or time between in-service failures; and

• in-service failures or deferred maintenance incidents attributed to key systems.

Department of Infrastructure 77 4.5.4 Replacement of lost or destroyed vehicles

Generally, if a vehicle is lost or irreparably damaged, the franchisee must make a payment to the State in respect of the lost or destroyed rolling stock. For trains, this is the value of the lost or destroyed rolling stock (as specified in the Franchise Agreement) up to a maximum of $5 million; for trams, it is a flat rate of $500,000. These amounts represent the insurance deductible for the rolling stock. Under the previous franchise arrangements, franchisees were required to replace any lost or destroyed vehicles. However, owing to the short franchise period under the current contracts, and the fact that the State is insuring the franchisees above the deductible level (see Section 4.3.4), it was decided to require franchisees to make a payment to the State rather than replacing lost or destroyed rolling stock. The State can then claim on its insurance policy for any amount greater than the deductible, and choose whether to replace the vehicle or deal with the loss in some other way (but it must work with the franchisee to alleviate any capacity issues which arise as a result).

These provisions do not apply where a vehicle has been identified as being obsolete (eg, Hitachi trains, Z1/2 Class trams). Such vehicles are effectively redundant and may be sold or scrapped by the franchisee once replacement vehicles have been brought into service.

4.6 Projects and project delivery

The ability for the State to ensure that major capital projects can be delivered is an essential aspect of the public transport franchising arrangements, particularly in light of the Government’s 20/2020 commitment. The Government also needs to be sure that the franchisees will actively support such major projects as the new ticketing system and the Commonwealth Games. At the same time, the franchisees’ involvement in assisting in the planning and design and even implementation of smaller-scale capital projects across the public transport network is also important.

4.6.1 New ticketing system

A new smartcard-based public transport ticketing system will be introduced in the metropolitan area during the term of the franchises, possibly with associated fare structure changes. In 2003 the State set up the Transport Ticketing Authority (TTA) under its ownership and direction, to manage the development and design phases of the ticketing project and to advise it on the commercial and operational implications of different procurement options. TTA is working closely with franchisees, the bus industry and Metlink to ensure as far as possible that the design, implementation and operation of the new ticketing system meets the requirements of the train, tram and bus operators.

Impacts and mitigation:

The implementation of the new ticketing system is likely to cause major upheaval to the operation of the public transport system, and during its installation and initial operation may lead to increased costs for labour, marketing, ticketing services (including parallel running of the existing system), and installation. In addition, revenue may be impacted during the transitional period while passengers are unfamiliar with the new system. These impacts create commercial risks for the franchisees, which the State sought to mitigate through the franchise contracts to prevent franchisees requiring higher base contract payments to compensate for risks that were outside of their control.

Under the new Partnership Agreements:

• franchisees are not required to meet the principal direct costs either of the existing ticketing system or the new one, thereby insulating franchisees from any direct costs associated with the existing ticketing system or the introduction and operation of the new ticketing system;

• the State and franchisees will negotiate the staffing levels, staff deployment and training requirements associated with the implementation phase of the new ticketing system. If agreement cannot be reached on these issues by negotiation, the State will mandate its requirements under the Franchise Sum Adjustment provisions and compensate franchisees accordingly (see Section 4.8.2);

Department of Infrastructure 78 • the State will fund the marketing program associated with the implementation of the new ticketing system; and

• franchisees are protected from any material adverse revenue impacts associated with the implementation of the new ticketing system. Under the Franchise Agreement, when the State reasonably believes that an event associated with the implementation of the new ticketing system has caused (or will cause) a reduction in real farebox revenue, the franchisees will be given the option to accept a guaranteed farebox revenue set at the level of previous years, escalated for inflation and historical growth rates.

Franchisee’s role in developing the new ticketing system:

To minimise the use of the State’s ad hoc powers of direction, the Franchise Agreement requires each franchisee as a matter of course to:

• cooperate fully in the development and implementation of the new ticketing system;

• engage from the commencement of the franchise period an appropriately senior and experienced full time manager empowered to represent its interests in the ticketing system, undertake internal communication and consensus building, and participate in joint work initiated by TTA; and

• provide the State or its nominee with free and unlimited access to any property owned or leased by the franchisee for the purposes of modifying or replacing that property to facilitate the implementation of the new ticketing system.

The successful and timely implementation of the new ticketing system is one of the criteria against which the State will determine whether it wishes to negotiate with each franchisee at the end of the franchise period for a possible extension to the Partnership Agreements.

4.6.2 Commonwealth Games

In March 2006, Melbourne will host the Commonwealth Games. The quality and coverage of the public transport services provided to support the Games will be a key determinant of their success. The preparations for the Games will require substantial participation from franchisees, bus operators and representatives of the State. The provision of services during the Games will also have revenue, cost and operational impacts on franchisees. The commercial risks for franchisees created by these impacts will need to be anticipated and mitigated.

The State and franchisees are working together to consider and agree all aspects of service delivery and information provision during the Games. To this end, each franchisee was required from the commencement of the franchise period to engage an experienced full time manager to support this joint planning process and to attend any meetings and participate in any joint working arrangements required by the State.

Games Services Remit:

In order to facilitate agreement with franchisees and ensure its expectations are met, the State has provided each franchisee with a Games Services Remit which sets out obligations and the State’s general expectations in key areas, including:

• the level and distribution of patronage during the period of the Games;

• the likely approach to ticketing for Games attendees (free travel, etc) and regular rail passengers;

• likely advice to the community on the use of the train and tram systems while the Games are in progress;

• high level requirements for service patterns, including clearance rates after Games events;

Department of Infrastructure 79 • maintenance and cleaning of assets before and during the Games, and for any capital upgrades to facilities which may be required;

• passenger information, revenue protection and system staffing during the Games; and

• special operations and security arrangements developed by Melbourne city authorities and Victoria Police for the Games, and the franchisees’ obligations to cooperate with such arrangements.

Games Services Plan:

In response to the Games Services Remit, each franchisee must provide a comprehensive indicative Games Services Plan. The Games Services Plan must include:

• a comprehensive draft Games Timetable for each mode, with supporting driver rosters and train/tram diagrams and an analysis of any obsolescent vehicles which may need to be retained to support the Games Timetable;

• a proposed program for the cost-effective upgrading, maintenance and cleaning of assets;

• proposals on the optimal deployment of customer-facing staff during the Games period, linked into a more general strategy for revenue protection, the provision of ticketing services and passenger information;

• an assessment of the impacts on staffing levels and staff training of the franchisee’s proposed Games Timetable and supporting strategies;

• a draft communications strategy, designed to inform passengers about the train and tram services (including the ticketing arrangements) available during the Games, which must link into the overall communications strategy developed by the Office of Commonwealth Games Coordination; and

• a cost estimate for each of these items.

The process of finalising a Games Services Plan is iterative. The State will provide ongoing feedback to franchisees by adapting and reissuing the Games Services Remit to reflect the ongoing progress of, and changes in, Commonwealth Games planning. The State can change the Games Services Remit at any time, in which case franchisees’ Games Services Plans must be amended accordingly. The State also has the power to audit the franchisees’ readiness for the Commonwealth Games.

Operation during the Games and financial arrangements:

During the Commonwealth Games:

• the OPR regime will not operate, although performance will still be monitored and may be reported by the State at the conclusion of the Games; and

• load standards are likely to be relaxed, although loadings will be monitored and changes to service patterns may be implemented if vehicles are unacceptably crowded.

Any capital expenditure necessary to facilitate service delivery for the Games will be funded by the State. In addition, the State will meet the franchisees’ direct additional costs of implementing the Games Services Plan, and make a per-kilometre payment for services run in addition to the normal timetable. As the revenue impacts and risks of the Commonwealth Games may be substantial, for the period of the Games the State will guarantee the franchisees’ revenue and make a payment to each franchisee such that, at a minimum, it receives a level of farebox revenue equal to the farebox revenue it earned in the corresponding period of the preceding year (escalated by inflation and trend revenue growth over that period).

Department of Infrastructure 80 The successful provision of high quality public transport services during the Commonwealth Games is one of the criteria against which the State will determine whether it wishes to negotiate with each franchisee at the end of the franchise period for a possible extension to the Partnership Agreements.

4.6.3 Regional Fast Rail

The Government’s flagship Regional Fast Rail project, providing significantly improved services between Melbourne and the regional centres of Geelong, Ballarat, Bendigo and the Latrobe Valley, is due for completion in mid-2005. The improvements to regional services include timetable amendments resulting in more services which arrive in Melbourne before 9.00am. This change will require train paths through the metropolitan area during the morning peak, putting pressure on the train franchisee’s metropolitan services, particularly on the already congested Dandenong corridor.

In the lead-up to the introduction of the new regional timetables, Connex and PTD will work together to resolve outstanding issues. The Franchise Agreement contains provisions for mitigating the effects of any disruption to metropolitan passenger services. At the State’s request Connex included within its Offer a commitment to provide train paths for the Regional Fast Rail project to enable the associated V/Line services to achieve their target journey times within the metropolitan area. The Franchise Agreement effectively caps the compensation payable to Connex for revenue losses and adverse operational performance impacts arising from the project. It also requires Connex to work with the State to minimise adverse impacts on metropolitan services through discrete infrastructure works and PSR changes to reduce the level of compensation required.

4.6.4 Spencer Street Station Redevelopment

Spencer Street Station is the terminus of Victorian regional train and coach services (operated by V/Line), other regional bus services, the airport bus (Skybus), and interstate services (to Sydney and Adelaide), as well as being served by Melbourne suburban trains. Unlike the rest of the rail network, Spencer Street Station is not owned by VicTrack. Instead, because of the large number of complex interfaces involved, it is owned by another State corporation, the Spencer Street Station Authority (SSSA). The tracks through the station (but not the station building or platforms) are leased to Connex under the Infrastructure Lease.

At the commencement of the current franchises, Spencer Street Station was undergoing a large- scale redevelopment, due for completion in 2005. The redevelopment of the station and its precinct is a public/private partnership between the Government and the Civic Nexus consortium, financed and led by ABN Amro Australia, and including Leighton Contractors, Honeywell and Delaware North Australia. The redevelopment includes new, state-of-the-art station facilities, including a roof over the station area, upgraded platforms, a new bus and coach station, retail plaza, car park and office building, with residential buildings to be added in the future. When construction is complete, Civic Nexus will operate and maintain the station for 30 years. Civic Nexus will not receive any payments from the State until the project reaches completion.

The station will remain operational throughout construction, and a series of contracts govern the arrangements covering this:

• Master Spencer Street Station Deed – describes the relationship that exists between exists between the SSSA, other State entities and the transport operators during redevelopment;

• Services and Development Agreement – details the rights and obligations of Civic Nexus with respect to the design, construction, commissioning, operation and maintenance of the improved station. This agreement provides for each of the rail operators to be consulted in relation to works at the station, and requires Civic Nexus to minimise disruption during construction and ensure the new works integrate properly with the existing infrastructure;

• Spencer Street Station Interim Access Agreements – require the SSSA to provide each of the train operators with access to the station during the construction phase to operate passenger services, and describes the nature of this access; and

• Occupations and Administration Agreement – provides for occupations of track and infrastructure which are necessary for Civic Nexus to undertake construction works, and

Department of Infrastructure 81 sets out compensation arrangements for the train operators in the event of late hand-back or delays to services caused by construction works.

When construction is complete, the same key contracts will govern the arrangements for the station’s operation, with the exception of the Interim Access Agreements, which will be replaced by the Spencer Street Station Access Agreements. These require Civic Nexus to provide each of the train operators with access to the station to operate passenger services, and describe the nature of this access.

4.6.5 Tram Travel Time Improvement Project

During the Refranchising Process, Yarra Trams identified the key risk to Melbourne’s tram network as being the gradual deterioration of average tram speeds over time as a result of worsening traffic congestion. Yarra Trams indicated that it would be able to reduce the cost of providing tram services (and therefore the funding required of the State) if these conditions could be turned around and average tram speeds increased. Benefits of improved running times are captured through increasing productivity of tram vehicles and drivers, as well as potential increases in patronage.

The Government therefore committed $30 million over the first two years of the franchise period to improve tram priority across the network. Works include improving priority for trams at traffic lights, better separation of trams from other road traffic, informing motorists of the rules relating to sharing the road with trams, and linking the Yarra Trams and VicRoads control centres to provide faster recovery from incidents on the network. Yarra Trams and VicRoads are responsible for delivering this project together. If it is successful, the Government may extend funding further into the franchise period.

The franchisee has forecast the benefits to average tram speeds that will result from the works undertaken during the first two years (as represented below), and built these benefits into the expected costs of tram operations. If the average tram speeds achieved through the priority program exceed the forecast, then Yarra Trams will share the benefits with the State through a payment of $3.6 million per annum per km/h that the average tram speed is greater than the forecast level.

Tram Speed Improvement

17.0

16.5 State shares benefit in this area Forecast Average 16.0 Tram Speed withproject 15.5

15.0

14.5 Forecast Average

Average Tram Speed (km/h) Tram Speed 14.0 withoutproject 2005/06 2006/07 2007/08 2008/09 2009/10 Year

4.6.6 Planning and delivery of other projects

Projects affecting the train and tram networks arise from a number of sources. The early termination of the 1999 franchises left a large number of planned projects uncompleted. Some of these were scrapped, while others were carried over into the new franchise arrangements for the current franchisees to implement. A number of major capital works were committed by the Government before the commencement of the franchise period, including the Vermont South tram extension and

Department of Infrastructure 82 Craigieburn rail electrification. In addition, projects are regularly proposed which are not rail-related, but which affect the operation of the train and tram system – eg, commercial developments over railway tracks.

A “project” can relate to infrastructure, rolling stock, information technology, or any other item that requires major investment. While the State is responsible for long term planning and for funding capital projects on the rail network, the franchisees, as the lessees of the train and tram networks and the principal repositories of operational expertise in the industry, must be heavily involved in selecting and scoping new projects from their inception. Franchisees are therefore expected and required under the Partnership Agreements to participate in medium and long term infrastructure and rolling stock planning activities, building upon the Government’s metropolitan travel plan. To this end, a cooperative framework exists between PTD and the franchisees, as shown below.

Long-term strategic plan Franchisee consultation (PTD)

List of projects; Franchisee input priorities, broad timing

Projects to be developed Franchisee Participation over 2-5 years

Agreed projects for Franchisee delivery, or State delivery implementation with requirement for franchisee assistance

As the State funds projects, it has the right to ultimately determine who will deliver a project and how. Three categories of project delivery are described in the Infrastructure Lease:

• State Rail Projects – rail projects delivered by the State;

• Franchisee Projects – projects delivered by the franchisee; and

• Major Non-rail Projects – projects delivered by non-rail Government agencies which impact on rail operations.

If the State nominates a new project, this becomes a Proposed Rail Project and is assessed by the State and franchisee together to determine its suitability to proceed to implementation. A decision will then be made on whether this should be implemented as a State Rail Project or a Franchisee Project.

Director nominates:

Proposed Rail Project Franchisee/Director develop case through Project Steering Committee Proceed? No

Yes Franchisee role: State Rail Franchisee Franchisee • Minimum; or risk • Enhanced Project Project

Department of Infrastructure 83 State Rail Projects:

Where the State is responsible for delivery of a project, the Infrastructure Lease requires the franchisee to be involved to at least a “minimum role” level, for which the State will reimburse the franchisee its direct costs. Reimbursement for the franchisee for its role in the delivery of State Rail Projects and for the financial and operational impacts of projects during construction is calculated using the Franchise Sum Adjustment procedures (see Section 4.8.2).

The minimum role that a franchisee must perform for any project involves:

• providing input, reviews and support at all project stages;

• ensuring compatibility and operational capability of the design for new services;

• providing and managing access to the network to facilitate project delivery;

• making vehicles and/or staff available for testing and commissioning; and

• managing and minimising disruption to the business.

For some projects, the State may encourage the franchisee to take on an enhanced role (eg, project manager, contractor). If the franchisee takes on such a role it will be paid for its services by the State, at a rate which is competitive and commensurate with the risk being accepted by the franchisee.

Franchisee Projects:

Franchisee Projects can arise from a number of sources:

• carryover projects from the previous M>Train/M>Tram contracts (including projects which were expected to be finished by the commencement of the current franchises, but which were still incomplete);

• carryover projects from the previous Connex/Yarra Trams contracts;

• Provisional Franchisee Projects – these are nominated projects in the Infrastructure Lease which require a detailed scope (and in some cases also a business case) to be provided by the franchisee before they will be funded by the State;

• Proposed Rail Projects – where the State has proposed a project and has decided that it will be implemented as a Franchisee Project; and

• Asset Improvement Projects – where a proposal by the franchisee has been approved and funded by the State (see Section 4.4.2).

The franchisee bears the full risk of delivery for Franchisee Projects.

Major Non-rail Projects:

The previous franchising arrangements did not adequately deal with projects undertaken by third parties (eg, VicRoads) but which affected rail services. This sometimes resulted in tensions between franchisees and third party project managers, as projects were delayed or rail services disrupted, or both.

Under the new Infrastructure Lease, where a Government agency implements a project which impacts on public transport services, the franchisee must provide all reasonable access and assistance to support efficient and effective completion of the project. In exchange, the project manager must indemnify the franchisee for all costs incurred as a direct result of the works, including OPR penalties accrued because of the project.

Department of Infrastructure 84 Rail extensions:

During the franchise period, the tram network will be extended from East Burwood to Vermont South along Burwood Hwy. This will be undertaken as a State Rail Project, with the franchisee undertaking at least the minimum role and negotiations taking place over an enhanced role. An extension of the tram network in Docklands will also be undertaken, through a delivery mechanism separate from the Infrastructure Lease. Yarra Trams will construct this extension in accordance with the terms of a Construction Control Deed with the State.

The metropolitan train network will be electrified to Craigieburn (from Broadmeadows), including construction of two new stations and train stabling. Since no firm decisions on the delivery method of this project were possible before franchise commencement, implementation will be handled using the principles in the Infrastructure Lease.

Franchisees are required to operate a specified level of service on these extensions when completed, and to maintain the new infrastructure.

A summary of key projects across the metropolitan rail industry is provided as Appendix 3 to this document.

4.7 Business planning and reporting

As part of its oversight of the public transport system, it is important that the Government has a clear understanding of the state of the network and operations, particularly when the short franchise length means that franchisees may not always have to live with the consequences of their actions. The Government needs to have an understanding of the franchisees’:

• financial health;

• business directions, including emerging issues and how these are being managed;

• contractual compliance; and

• key outcomes and outputs.

The 1999 franchises included a requirement for franchisees to provide Business Plans (updated annually) to the State, including financial information and other reports on performance. However, the Franchise Agreement lacked clarity regarding these requirements. As a result, the quality of information provided through the Business Plans was poor, different accounting standards and practices inhibited a clear understanding of franchisees’ financial positions, and key performance information was inconsistent and patchy.

The arrangements under the new Franchise Agreement are more prescriptive, providing clear expectations for the State and franchisees regarding what information should be presented and how.

4.7.1 Franchisee plans

Achieving a common understanding of the financial, operational and asset stewardship outcomes of the train and tram franchises (and Metlink) is a critical aspect of ongoing relations between the State and the franchisees. In a number of vital functional areas the State needs to approve each franchisee’s proposed approach at a relatively detailed level. This is achieved through the approval of specific plans in a range of areas. These plans address in some detail the activities proposed to be carried out by the franchisee each year and the obligation for the franchisees (individually and collectively) to implement these plans:

• Forward Capacity Plan – highlights any vehicle loading pressures (including load standard breaches) and outlines measures proposed by the franchisee to alleviate these;

Department of Infrastructure 85 • Franchisee’s Action Plan – outlines works to be undertaken during the franchise term to work towards compliance with the Transport Standards. Officially lodged with HREOC;

• DDA Milestone Plan – details works proposed to be undertaken by the franchisee over the next three years in order to work towards compliance with the Transport Standards in accordance with the Franchisee’s Action Plan;

• Annual Works Plan – identifies specific infrastructure maintenance and renewal works to be undertaken during the following year, based on the Asset Management Plan (see Section 4.4.1);

• System Upkeep Plan – details processes in place in relation to system cleanliness and presentation to ensure the minimum standards in the Franchise Agreement are met;

• Vegetation Management Plan – details processes in place in relation to management of vegetation on franchisee leased land to ensure the minimum standards in the Infrastructure Lease are met;

• Environmental Management Plan – details processes in place in relation to management of environmental risks on franchisee leased land to ensure the minimum standards in the Infrastructure Lease are met;

• Rolling Stock Management Plan – sets out rolling stock maintenance and renewals works to be undertaken;

• Annual Rolling Stock Maintenance Plan – sets out preventative maintenance works to be undertaken with regard to rolling stock; and

• Asset Improvement Project list – lists and describes the Asset Improvement Projects recommended by the franchisee for implementation.

Metlink is also required to submit a number of plans to the State:

• Metlink Business Plan – outlines Metlink’s planned strategy and initiatives for implementation during the following three years;

• Network Marketing Strategy – provides a three-year strategy to grow revenue and patronage through marketing;

• Network Marketing Plan – details specific marketing activities and initiatives to be undertaken during the following year, based on the Network Marketing Strategy; and

• Network Revenue Protection Plan – sets out strategies to promote increased fare compliance, including staff deployment and revenue protection initiatives.

4.7.2 Business Plans

Before the commencement of the franchise period, each franchisee was required to have developed an Initial Business Plan, which outlined the franchisee’s strategy and structure for the entire franchise period.

The Franchise Agreement includes a requirement for each franchisee to prepare a Business Plan each year which must be consistent with the Initial Business Plan (unless agreed otherwise by the State). This process ensures that the State has a thorough understanding of the business framework within which the plans in Section 4.7.1 above are to be prepared, and ensures that a common understanding is achieved of the wider operational activities and financial outcomes projected. The Business Plan articulates the franchisee’s strategy for managing each key aspect of its business, linking each strategy to specific financial forecasts and to the State’s objectives. The Business Plan provides a strategic and financial context for other plans, and the process in which it is approved and monitored by the State is a key aspect of relationship management and franchise compliance.

Department of Infrastructure 86 The Business Plan spans a three-year planning horizon, with the first year of the plan setting the operational and financial budget for the forthcoming year. The following functional areas are prescribed in the Franchise Agreement:

• operations and service management – those aspects of management and planning which affect the quality and timeliness of services;

• customer service – those aspects of management and planning which affect passengers’ perception of the quality of service;

• marketing and revenue – strategies and activities to maintain and enhance patronage and revenue, including strategies and the deployment of resources to minimise fare evasion;

• rolling stock management – the management and maintenance of existing and new rolling stock;

• infrastructure – the management, maintenance, renewal and improvement of rail infrastructure;

• safety – all aspects of safety, including safe work practices, passenger security, environmental safety and operational safety;

• organisational – the general management of administrative functions, including employee management, industrial relations, senior staffing and organisation structure; and

• information technology – maintenance and operation of IT assets, IT strategy and forward planning.

For each functional area the Business Plan outlines the existing state of operations and management, objectives, emerging issues and business pressures, opportunities, business response and initiatives, key performance indicators, and a summary of the financial position and assumptions underpinning this. The Business Plan also includes a retrospective review of performance in these areas over the preceding year.

Each franchisee must also provide financial statements in accordance with the accounting principles and templates provided in the Franchise Agreement (even if their other external reporting format is different from this).

Although the Business Plan is an annual plan, to allow both the franchisee and the State to monitor and comment on performance, monthly and quarterly reports must also be provided by the franchisee to the State. These reports include highlights over the period, a summary of any issues, updates on key performance indicators, and specified details of financial performance including trends and an explanation of variances. The State and franchisee meet monthly to discuss KPIs (by exception) and important issues of the day, and conduct a major review of progress each quarter based on the reports provided.

4.7.3 Key Performance Indicators

Key performance indicators (KPIs) form an important aspect of the business planning and monitoring and compliance process. In addition to KPIs provided by the franchisees, the Business Planning Practice Note specifies certain core KPIs which are central to franchise operation and which must be included under the functional areas as part of the Business Plan. These may also be used as a basis for any payment under the Service Quality Incentive regime (see Section 4.2.3), should the State choose to utilise this.

Department of Infrastructure 87 4.8 Contract variations

Because public transport is a public service, the State requires the flexibility over time to vary the requirements it places on franchisees in areas like service delivery, fares, ticketing and project delivery should it believe it is necessary. At the same time, it is important that franchisees should not suffer any material financial detriment as a result of these contract changes imposed by the State. The Franchise Agreement therefore establishes a Franchise Sum Adjustment methodology to compensate franchisees for any adverse impacts resulting from contract variations required by the State.

4.8.1 State’s power to vary contract conditions

Under the Franchise Agreement the State has a right to alter the quality or the quantity of the public transport services it purchases, including (but not limited to):

• timetables and the PSR;

• ticketing, fare structures and pricing arrangements; and

• service quality standards, including cleanliness standards, maintenance arrangements, the management of stations, and staffing/staff training obligations.

Some of these variations are implemented under specific regimes provided for in the Franchise Agreement. Others can be done through the more general contract variation provisions. If the State requires a contract variation under the general contract variation provisions, it must inform and consult with the franchisee and consider any feedback provided by the franchisee.

4.8.2 Franchise Sum Adjustments14

In order to compensate a franchisee for any negative impact on its costs or revenue resulting from a contract variation or other specified event, a Franchise Sum Adjustment is calculated when a contract change is implemented. For most contract variations, the net financial impact of the change is calculated using detailed assumptions and principles set out in the Franchise Agreement. If the net impact on the franchisee is negative, the State compensates the franchisee by making a Franchise Sum Adjustment to the franchisee’s monthly Franchise Payment.

A franchisee is entitled to retain the benefits of minor contract variations which have a positive net financial impact on it. However, in the case of variations that have a positive net financial impact on the franchisee of more than $10 million (train) or $5 million (tram) over the remainder of the franchise term, the net financial benefit will be deducted from the franchisee’s Franchise Payments. The State will also receive the benefit of any above-inflation fare rises (see Section 4.9.2).

If the State and the franchisee cannot agree at any stage of this process (eg, on the materiality of a contract change, or on the value of compensation to be paid to the franchisee), an independent expert will be engaged to resolve the dispute and make a binding determination (based on the principles in the Franchise Agreement and the Franchise Sum Adjustments Practice Note).

4.9 Payments

Payments flow between the State and the franchisees on a transparent basis within a framework that is clearly understood by both parties. The formulae for payments and the manner in which they will be made are covered in Schedule 14 of the Franchise Agreement and supported by a separate Practice Note. The order in which payments must be made is also set out in the Franchise Agreement.

To protect franchisees from movements in inflation, most payments are indexed to a CPI multiplier from 2005 onwards.

14 The Franchise Sum Adjustments Practice Note provides more detail on the operation of the contract variation and compensation process.

Department of Infrastructure 88 Payments can be categorised under four headings, each of which is examined in more detail below:

• base contract payments;

• adjustment payments;

• risk sharing payments; and

• incentive payments.

(Payments relating to Metlink are discussed in Section 3.3.5.)

4.9.1 Base contract payments

Base contract payments are made to the franchisee for providing its core services under the Partnership Agreements in recognition of the fact that public transport in Melbourne is loss-making. These comprise:

• Franchise Payment – this is the single largest payment made from the State to the franchisee. The monthly Franchise Payment is composed of a fixed amount (from the franchisee’s Offer) reflecting the base operating payment, and adjusted for any force majeure events, Rolling Stock Adjustment and Franchise Sum Adjustments:

o Fixed Monthly Franchise Sum – a fixed amount paid monthly to the franchisee by the State, based on the amounts set out by the franchisee in its Offer;

o Force Majeure Adjustment – a payment by the franchisee to allow the State to claw back any windfall financial gain to the franchisee resulting from a force majeure event which causes serious disruption to service delivery and therefore reduces operating costs (subject to a materiality threshold);

o Rolling Stock Adjustment – a payment by the State to the franchisee to meet the cost of rolling stock lease payments as each unit of new rolling stock is introduced into service; and

o Franchise Sum Adjustment – a payment from or to the State to compensate for the (aggregate) net financial impact stemming from contract variations or other specified events which impact the franchisee’s revenue or costs.

• Concession Top-up Payment – this is paid to the franchisee in recognition of the fact that concession fares are approximately half the full fare. The payment is made quarterly and is 50% of the franchisee’s concession fare revenue, adjusted for the level of concession fraud.

4.9.2 Adjustment payments:

Adjustment payments are made as “true-ups” for areas where the exact correct amount was not ascertainable at the time the contracts were signed. These comprise:

• Special Event Balancing Payment – this adjusts differences between actual special event service levels and a pre-set level of services, based on a per-kilometre amount (see Section 4.1.2);

• Games Payments – these are discussed in Section 4.6.2 and include the:

o Games Revenue Guarantee Payment – compensates the franchisee for adverse revenue impacts associated with the implementation of the Commonwealth Games Services Plan; and

o Games Kilometre Payment – for additional services run during the Commonwealth Games, according to a set rate per kilometre operated;

Department of Infrastructure 89 • New Ticketing Revenue Guarantee Payment – payment is made when implementation of the new ticketing system causes a real reduction in quarterly farebox revenue. Once triggered (and accepted by the franchisee), the payment regime cannot be removed. See Section 4.6.1, but note that this payment is two-way (ie, the franchisee must make a payment to the State if revenue is higher than in previous years);

• Employee Entitlements Payment – this is an annual “true-up” for the difference between actual employee entitlement costs and the franchisee’s forecast amounts (see Section 4.3.5);

• Fare Change Adjustment Payment – if the State elects to increase public transport fares by more than the increase in inflation, the Fare Change Adjustment Payment allows it to claw back the extra revenue generated by the fare increase. This is a payment from the franchisee to the State, the scale of which is determined by the application of pre-defined demand elasticities, documented in the Franchise Agreement. The net impact on Concession Top-up is also provided for;

• Redundancy Reimbursement Payment – if the franchisee employs, within one year of franchise commencement, an employee of M>Train/MTram or Thiess or Bombardier to whom the franchisee had previously failed to make an offer of employment at franchise commencement, the franchisee must make a payment to the State equal to any redundancy payment made to that employee on termination of their employment with M>Train/MTram, Thiess or Bombardier;

• Access Charge Adjustment Payment (Train only) – and Freight Australia procure access to the metropolitan track from Connex under an Access Agreement. The Access Agreements under the original franchise contracts expired with the termination of the original Franchise Agreements, and Connex was therefore required to negotiate new Access Agreements with Pacific National and Freight Australia.

With this in mind, an Access Charge Adjustment mechanism was included in the Franchise Agreement to provide for the situation where access charges are different under a new Access Agreement. The franchisee must pay the State any increase in access payments received from Pacific National and Freight Australia, while the State must make up any shortfall in the event that access charge payments to the franchisee are lower under the renegotiated contracts; and

• Tram Travel Time Improvement Payment (Tram only) – to the extent that the Tram Travel Time Improvement Project is more effective than expected, the franchisee must make a payment to the State to share the benefits in excess of those assumed in the franchisee’s Offer (see Section 4.6.5).

In addition, two one-off adjustment payments were designed to be made at franchise commencement:

• Employee Transfer Adjustment Payment (Train) / Excess Redundancy Payment (Tram) – payment from the franchisee to the State if the actual number of employees taken on by the franchisee at franchise commencement was fewer than it forecast in its Offer to the State; and

• Inventory Value Adjustment Payment (Train) / Asset Value Adjustment Payment (Tram) – if the purchase cost of Thiess assets (M>Train) or Bombardier and Thiess assets (M>Tram) was less than that forecast, the franchisee made a payment to the State equal to thedifference(atwo-waypaymentinthecaseofTram).

4.9.3 Risk sharing payments

Risk sharing payments are made to offset or share the risk between the private and public sectors. These comprise:

Department of Infrastructure 90 • Revenue Risk Sharing Payment – an annual payment (if triggered) from the State to the franchisee, where the State pays a proportion of the shortfall between the franchisee’s actual farebox revenue and a threshold level (see Section 4.3.1); and

• Profit Sharing Payment – an annual payment (if triggered) from the franchisee to the State, where the franchisee pays the State a proportion of its profit above a threshold level (see Section 4.3.2).

4.9.4 Incentive payments

Incentive payments are made to incentivise the franchisee to provide excellence in service delivery to passengers. These comprise:

• Operational Performance Regime Payment – monthly payment to or from the State according to the franchisee’s service performance against a set target value (see Section 4.2.1);

• Service Growth Incentive Payment – annual payment from the State to the franchisee for services operated in addition to those operated at franchise commencement (see Section 4.2.2); and

• Service Quality Incentive Payment – payment (if activated) from the State as a discretionary bonus to the franchisee for achievement of performance targets and KPIs as specified by the State (see Section 4.2.3).

4.10 Metlink

Metlink has a number of obligations under its contracts with the State, mainly through the Metlink Services Agreement, but also the Revenue Sharing Agreement, the OneLink Management Agreement and others. Metlink has also entered into Operator Services Agreements with Yarra Trams, Connex, V/Line and the Bus Association of Victoria. These Operator Services Agreements specify how Metlink will work with each operator to provide the key services required of it under the Metlink Services Agreement and the other Metlink documents. They set out the funding arrangements under which the rail operators in particular will “buy” services from Metlink.

Metlink’s main responsibilities are outlined below.

4.10.1 Information services

Metlink collects a range of defined data, and designs, conducts, analyses and reports the results of specific surveys across the metropolitan public transport network. These include:

• fare evasion and valid concession percentage surveys every six months;

• validation rate surveys every quarter, which enable it to estimate patronage on each mode; and

• origin-destination surveys periodically.

All data collected by Metlink is the property of the State and is reported to the operators and PTD. In addition, Metlink is required to maintain a database of market information about public perceptions and usage of the metropolitan public transport system.

4.10.2 Marketing

Metlink receives an annual Network Marketing Payment from the State of $5 million, which must be spent on marketing of the public transport system. Each year, Metlink prepares a three-year rolling Network Marketing Strategy which presents strategies to inform passengers about the public transport system, including system-wide branding and the building and protecting of the Metlink

Department of Infrastructure 91 image. The strategy also indicates how information will be gathered to identify customer needs, trends and opportunities.

Each year, Metlink also develops and implements a 12-month Network Marketing Plan to give practical effect to the high level directions in the Network Marketing Strategy. In addition, Metlink maintains a Master Style Guide, which prescribes the designs, layouts and branding standards to be adopted by metropolitan public transport operators and Metlink itself in the provision of passenger information.

4.10.3 Wayfinding Signage Project

By the end of 2003, there were over 56,000 items of signage in hundreds of different styles across the public transport system, leading to confusion for passengers and providing no unified sense of a public transport brand. The advent of Metlink provided the opportunity to present public transport as a single, integrated system, and to provide information to passengers in a clear and consistent way. To this end, the Wayfinding Signage Project is a $23 million roll-out of standardised, DDA-compliant directional signage across the train, tram and bus networks, to be completed by mid-2006.

4.10.4 Customer services

Metlink is responsible for managing a range of public information sources, including:

• a call centre which provides passengers with information about all public transport services across Victoria. The call centre is operated in accordance with specified standards which require a progressive improvement in performance tied to the website enhancements described below. Performance is monitored through KPI reporting tied to “hard measures” such as response times, and to softer, more quality-based measures such as “mystery shopper” and customer satisfaction surveys;

• a website which provides passengers with information about all public transport services across Victoria. The website is operated in accordance with minimum functionality requirements, including a search facility, online maps and a progressively rolled-out journey planner facility. By late 2005, the journey planner must be expanded to cover all metropolitan train, tram and bus services, and all V/Line and interstate train services. A range of data on the usage of the website is collected every six months to inform efforts at continuous improvement;

• the Metlink Shop on Swanston Street;

• the Central Pass Office, which is responsible for issuing of passes to passengers who are entitled to free public transport (eg, MPs, police, some ex-PTC staff);

• designing and producing printed materials (eg, maps, posters and local government area travel guides) which relate to more than one metropolitan public transport operator. It also designs templates for operator-specific passenger information. All printed materials are designed in accordance with the Master Style Guide; and

• establishing and monitoring complaints handling procedures which comply with Australian Standard AS4269-1995 for all complaints received regarding passenger services in Victoria. The complaints handling procedures specify how complaints are to be received, logged and transferred to the relevant operator for response. That operator is then required to deal with the complaints within specified timelines related to the urgency of the complaint. Metlink also provides regular reports to the State on complaints received by all operators.

4.10.5 Revenue allocation

Under the Revenue Sharing Agreement, Metlink receives all monies collected on behalf of the metropolitan rail franchisees, bus operators and V/Line Passenger. Each day, Metlink distributes the farebox revenue it has received as follows:

• V/Line is paid its share of the farebox revenue; then

Department of Infrastructure 92 • any cash collected on behalf of a third party or for non-ticketing items (eg, bicycle lockers) is paid into the account of the operator who collected the cash; then

• receipts from student ID cards are paid to the State; then

• Metlink distributes the remaining cash as follows:

o Connex – 40%;

o Yarra Trams – 40%; and

o the State – 20%.

4.10.6 Ticketing services

While the OneLink Service Contract is between the State (TTA) and OneLink Transit, day-to-day management of this contract is handled by Metlink in accordance with the OneLink Management Agreement.

Under the OneLink Management Agreement, Metlink is appointed as “TTA General Manager” and as TTA’s agent for the purposes of managing the OneLink Service Contract. However, while Metlink acts as its agent, TTA remains the principal for the OneLink contract. TTA's rights under the OneLink Management Agreement are in practice exercised by PTD, which acts as a "one-stop- shop" for all matters relating to the OneLink Service Contract, liaising as necessary with TTA behind the scenes.

Metlink is responsible for reporting to PTD and TTA on the performance of the existing ticketing system.

State retained rights:

There are certain rights under the OneLink Service Contract which may not be exercised by Metlink except with the approval or by the direction of the State. These State retained rights include:

• end of term arrangements;

• default or termination rights;

• variations and other amendments to the OneLink Service Contract;

• new ticketing system issues; and

• vandalism issues.

Termination and extension:

The OneLink Management Agreement may be extended by PTD if the OneLink Services Contract is extended by TTA. In such circumstances, Metlink and the PTD will negotiate any changes that are required to the OneLink Management Agreement or to payments, with resort to dispute resolution by an independent expert if required.

The OneLink Management Agreement will automatically terminate when the OneLink Services Contract terminates. However, the it may also be terminated at three months’ notice by PTD if TTA considers that its termination is necessary or desirable to facilitate the implementation of the new ticketing system.

If the OneLink Management Agreement is terminated, PTD has the option to terminate the Metlink Services Agreement and other Metlink contracts. In practice, this “break point” will give the parties an opportunity to negotiate and agree a restructuring of Metlink to fit in with the new environment created by the introduction of a smartcard-based ticketing system.

Department of Infrastructure 93 Other ticketing services:

Metlink is responsible for developing pricing and other strategies to encourage patronage growth and growth in off-system ticket sales. Since fares and fare structures are regulated under the Franchise Agreement, any changes require the approval of the State.

Metlink also coordinates operators’ advice to PTD and TTA on the design of the new ticketing system.

4.10.7 Public transport advocacy

Metlink acts as an advocate for issues affecting the whole of the metropolitan public transport system relevant to patronage growth, the existing ticketing system, customer information and the retail network. Metlink (in consultation with PTD) develops strategies to promote metropolitan public transport and influence policy to achieve the Government’s objectives for patronage growth.

4.10.8 Coordination of revenue protection activities

Each year, Metlink prepares a Network Revenue Protection Plan in conjunction with the metropolitan train, tram and bus operators. The plan covers the conduct, training and deployment of Authorised Officers, the measurement of fare evasion, and joint activities around marketing, communications and special events relating to fare compliance. See Section 4.1.3 for more detail on this area.

4.10.9 Business planning and reporting

In the same way as the franchisees are required to produce a detailed annual Business Plan, each year Metlink is required to submit a Business Plan and budget to the State which provides a detailed perspective on Metlink’s activities and expenditure over the ensuing one- and three-year periods.

Metlink is also required to report regularly to PTD on a range of other activities, including its financial performance against budget, and KPIs related to the services it provides under its contracts with the State.

Department of Infrastructure 94 Chapter 5: The Legal Framework

The franchised metropolitan rail industry operates within a complex contractual framework. The refranchising of metropolitan passenger rail businesses involved the establishment of a suite of Partnership Agreements between the State, the franchisees, Metlink and key sub-contractors and suppliers. These Partnership Agreements are sub-divided as follows:15

• Transaction Documents – governing the relationship between the State and the franchisees, including the Sale of Assets Agreement, the Franchise Agreement, the Infrastructure Lease Agreement, and supporting agreements;

• Metlink Agreements – establishing the ownership, governance and funding of Metlink and its relationship with the State and other key stakeholders;

• Direct Agreements – governing the relationship between the State and the franchisees’ key suppliers or contractors, most notably the suppliers and maintainers of rolling stock; and

• Interoperator Agreements – governing the inter-relationship between the franchisees and other industry parties, eg to support network-wide services.

A list of documents associated with refranchising is provided as Appendix 4 to this document.

5.1 Transaction Documents

The principal Transaction Documents are as follows:

• Sale of Assets Agreements, for the sale of assets of the M>Tram and M>Train businesses to Yarra Trams and Connex;

• Transfer Agreements, for the transfer of Thiess and Bombardier assets and employees to Yarra Trams and Connex;

• Franchise Agreements between the Director of Public Transport and the franchisees under which the continued provision of passenger rail services is regulated and a base operating payment and various incentives are paid;

• Infrastructure Leases for the lease of rail infrastructure (including stations and track) by the Director of Public Transport to the franchisees (the Director leases that infrastructure from VicTrack under a Head Lease); and

• supporting agreements, supporting the Director of Public Transport’s rights under the above Transaction Documents, including charges, Performance Bonds, indemnities and Deeds of Subordination.

5.1.1 Sale of Assets Agreements

The Sale of Assets Agreements are the key contracts governing the transition of assets, employees and contracts of the M>Train and M>Tram businesses from control of the Receivers to the franchisees. They relate primarily to the two-month period between the signing of the Franchise Agreement and Infrastructure Lease, and the completion of the sale and commencement of franchise operation.

The key provisions in each Sale of Assets Agreement relate to:

• the scope of the sale – the physical assets (other than infrastructure) and contracts which were to be transferred to the franchisee (or its nominees) at the point where the franchise commenced;

15 Note that neither this section, nor Appendix 4, provides an exhaustive list of contracts.

Department of Infrastructure 95 • Completion – the timing of the actual handover of the running of the business and ownership of assets from the Receivers to the franchisee, and the various obligations on the two parties at the point of completion;

• employees – the handling of employees during the transition period, including specific timelines and procedures for selecting those employees who would be given jobs by the franchisee. The Sale of Assets Agreement ensured that redundancy costs were properly allocated between the State and the franchisee; and

• true-up – the arrangements for ensuring that financial flows occurring during the transition period (eg, as a result of major projects or working capital payments) were allocated between the State and the franchisee in accordance with an agreed set of rules.

5.1.2 Transfer Agreements

Under the original 1999 franchising arrangements, M>Train sub-contracted its infrastructure maintenance obligations to Thiess Infraco, and M>Tram sub-contracted its infrastructure maintenance obligations to Thiess and its rolling stock maintenance obligations (for existing vehicles) to Bombardier. As part of the original privatisation process, Bombardier and Thiess acquired assets and employees from the Swanston Trams and Bayside Trains statutory corporations. They were therefore required to enter into Direct Agreements under which those assets and employees would be transferred to a new operator on termination of the M>franchises.

The Bombardier and Thiess Transfer Agreements give effect to the transfer of these assets and employees to Yarra Trams and Connex. They are equivalent to the Sale Agreements covering the transfer of assets and employees from M>Tram and M>Train.

5.1.3 Franchise Agreements

The Franchise Agreements are perhaps the most important legal documents in the new Partnership arrangements. They imposes a range of obligations on franchisees in relation to passenger rail services, monitoring and approval arrangements, financial structuring, enforcement powers and compliance with relevant contracts. They also provide a framework of incentives and penalties designed to improve the punctuality and reliability of train and tram services and to encourage franchisees to increase patronage.

The majority of the contract design principles and initiatives set out in Chapter 4 are contained within the Franchise Agreements.

Practice Notes:

The Franchise Agreements are supported by a series of Practice Notes which are generally not legally binding. These provide clarity and assistance to franchisees (and the State) in the form of more detailed explanations of principles and mechanisms within the Franchise Agreements. In cases where detailing a process within the legal contract would not be desirable or appropriate, a Practice Note can provide worked examples or indicate the State’s expectations. For example, Practice Notes explain how to prepare a Business Plan in a form acceptable to the State, how rolling stock condition index methodology will be applied, and how payments to and from the State will be calculated.

Practice Notes are prepared by the State, which can amend or add to them at any time.

5.1.4 Infrastructure Leases

Along with the Franchise Agreements, the Infrastructure Leases are key Partnership contracts. The Infrastructure Leases govern the operation, maintenance and future development of the track, signalling and other infrastructure over which Victoria’s trains and trams are run.

One of the principle aims of the Infrastructure Leases is to ensure that the train and tram networks are adequately maintained. Franchisees’ contracts with the State run for around five years; the networks over which they operate have a much longer lifespan. A key aim for the Government in

Department of Infrastructure 96 drawing up the Infrastructure Leases was to ensure that franchisees did not allow the condition of the network to deteriorate as their franchises came to an end. The Government has sought to ensure that franchisees do not seek to cut costs by deferring or under-investing in maintenance, and do not impose increased future costs on the State as the long term owner of the network.

The Victorian Rail Track Corporation (VicTrack) is the owner of the rail infrastructure leased to franchisees. The Director of Public Transport leases the infrastructure from VicTrack and manages the Infrastructure Leases on behalf of the State.

Lease and restrictions:

As Head Lessor, VicTrack has exclusive rights to install pipes, cabling and other defined infrastructure (eg, telecommunications or fibre-optic cabling) on the land leased to the franchisee. The Infrastructure Lease gives VicTrack exclusive “air rights” for property developments above or on top of land, track and buildings. In other words, through VicTrack, the State retains the commercial rights to exploit air space and to install telecommunications and other communications/pipeline infrastructure on the land leased to the franchisee. If such development work takes place, the franchisee must provide access but will be compensated for disruption caused.

5.1.5 Supporting agreements

There are three principal agreements which support the Franchise Agreements and the Infrastructure Leases:

• Deed of Charge – each franchisee has granted a charge over its assets to secure performance of its obligations to the Director under the Franchise Agreement and the Infrastructure Lease;

• Performance Bond – each franchisee has arranged for a Performance Bond to be issued in favour of the Director. The Director may draw upon the Performance Bond to meet the payment obligations of the franchisee under the Franchise Agreement and the Infrastructure Lease; and

• Deed of Subordination – under this document, the institution providing the Performance Bond on behalf of a franchisee agrees to rank after the Director and the franchisee’s unsecured creditors.

5.2 Metlink Agreements

The contractual framework supporting Metlink is based on the following main documents:

• Metlink Services Agreement – sets out all the services the Director of Public Transport is purchasing from Metlink and the payment regime for those services;

• OneLink Management Agreement – between the Director, Metlink and TTA, which describes the delegated role which Metlink will play in the day-to-day management of the existing OneLink Service Contract;

• Revenue Sharing Agreement – between the Director, Connex, Yarra Trams, V/Line and Metlink, which describes how revenue will be collected by Metlink on behalf of the operators and the Director and distributed between them; and

• Operator Services Agreements – between Metlink and each of the main operators (Yarra Trams, Connex, V/Line and the Bus Association of Victoria), which set out the obligations of the parties to supply services to each other and the related funding arrangements.

The practical obligations arising from these contracts are discussed in Section 4.10.

Department of Infrastructure 97 5.3 Direct Agreements

Provided that they comply with the terms of their contracts with the State, franchisees are generally free to run their businesses on a commercial basis, negotiating freely with contractors for the supply of support services. There are, however, a number of “key contracts” for goods and services which are crucial to the operation of train and tram services.

The primary aim of Direct Agreements (executed between the State and the franchisee’s suppliers) is to protect the State’s interests when the main franchise terminates (either through natural expiry or through default) by securing short term continuity of supply and/or access to warranties and intellectual property rights. In the case of Franchise Entities, Direct Agreements also secure the effective transfer of assets, personnel and any sub-contracts to a successor operator.

Direct Agreements have been entered into with a range of key suppliers, including suppliers of electricity for traction power, leases, and supply and overhaul of rolling stock products, which the State would want to see continued, at least in the short term, if the main Partnership Agreements came to an end. The franchisees are required to procure Direct Agreements for any new key contract entered into during the franchise period.

5.3.1 Franchise Entity Direct Agreements

Specially developed Direct Agreements have been entered into with Franchise Entities (such as MainCo and AMTL), which are responsible for managing a substantial part of the franchise business and have assumed control of key assets and personnel which are critical to the ongoing operation of the franchises.

The main purposes of Franchise Entity Direct Agreements are to:

• bind Franchise Entities into certain provisions of the Franchise Agreement, eg in relation to intellectual property, information technology, confidentiality and information provision; and

• ensure the transfer of assets and employees to a successor operator (or the State) at the end of the franchise; and

• enable continuation of the contracts for a six-month period at the end of the franchise at the State’s option.

5.3.2 New Rolling Stock Direct Agreements

The suppliers, lessors and the maintainers of the new rolling stock have each entered into Direct Agreements with the Director of Public Transport which guarantee the State continued access to, and maintenance of, the new rolling stock in the event of an early termination or expiration of the franchise. The key Direct Agreements relevant to new rolling stock are:

• New Rolling Stock Supply Direct Agreement – ensures that the Director may step in to remedy any breach of the Supply Agreement by the franchisee or the purchaser, prevents the supplier from terminating the Supply Agreement, and provides for transfer of intellectual property on termination of the Franchise Agreement;

• New Rolling Stock Lease Direct Agreement – between the Director and the lessor of the new rolling stock, which ensures that the incumbent franchisee and any successor franchisee continue to have access to the new rolling stock and which obliges the Director to take over the rights and obligations of the franchisee under the lease in certain circumstances (eg, if the Franchise Agreement terminates early or expires); and

• New Rolling Stock Maintenance Direct Agreement – between the Director and the maintainer of new rolling stock, which ensures that the incumbent franchisee and any successor franchisee continue to have access to certain essential maintenance assets (such as special tools and spares) and services. This agreement also enables continuation of the NRS maintenance agreement beyond the end of the franchise term.

Department of Infrastructure 98 5.3.3 Interoperator Agreements

The 1999 rail privatisation process involved the disaggregation of the Public Transport Corporation into no fewer than eight statutory corporations. This disaggregation in turn created the need for over 100 interoperator agreements. With two train and tram companies in the metropolitan area, interoperator agreements were required to govern the use and supply of key “joint” services such as power supply, track access and train/tram control.

The consolidation of the metropolitan public transport industry into one train operator and one tram operator removed the need for many of these contracts. Yarra Trams and Connex have an agreement between them governing the maintenance of rail squares (where the tram and train networks intersect). Remaining interoperator agreements include track access agreements between Connex and third party operators such as V/Line Passenger, Freight Australia, CountryLink and Great Southern Railway.

5.4 Enforcement of contracts

The Franchise Agreement provides the Director of Public Transport with a range of enforcement powers to ensure that franchisees honour their contractual obligations. There are four levels of enforcement action:

• Call-in – a requirement on the franchisee to meet with the Director and to bring forward plans for corrective action in the event that the franchisee fails to meet specified thresholds for the operation of passenger services;

• Breach – a requirement that the franchisee draw up a formal “Cure Plan” and take remedial action in the event that a contravention of the Franchise Agreement occurs (or for three Call-ins within a three-year period). A failure to remedy any single breach may result in a financial penalty of up to $1 million, or $10,000 per day if the breach continues – whichever is greater;

• Step-in – where a very serious contravention of the Franchise Agreement occurs, the Director has powers, in defined circumstances, to appoint a third party to temporarily take over the running of all or part of a franchise business in order to restore normal passenger services; and

• termination – the Franchise Agreement specifies circumstances where the Director has the power to terminate the franchise (eg, insolvency, persistent breach of the contract, or a breach that fundamentally affects the delivery of passenger services or safety).

The Franchise Agreement envisages that a persistent failure to remedy a contravention may result in escalating levels of enforcement, from Call-in through Breach (possibly accompanied by financial penalties) and, ultimately, on to the option of termination by the State.

Force majeure:

There may be circumstances in which, through no fault of its own, a franchisee is unable to comply with the terms of the Franchise Agreement. These circumstances range from major natural disasters, wars or power shortages through to a change in law or an incident of industrial action in other parts of the economy. In these defined circumstances, the franchisee may be temporarily released from some or all of its obligations to the extent necessary – provided that the State is satisfied that the relevant disruption could not have been avoided by reasonable preventative action by the franchisee.

Enforcement of Metlink contracts:

The powers of enforcement to ensure Metlink complies with its obligations are equivalent to the provisions in place under the Franchise Agreements. Under the Metlink Services Agreement, a failure by Metlink to meet an obligation under any of a range of Metlink contracts16 is subject to an escalating enforcement regime of Call-in, Breach, Step-in and ultimately termination. The major

16 Any of the contracts numbered 1 to 12 under the Metlink Documents heading in Appendix 4.

Department of Infrastructure 99 difference between franchisee and Metlink breaches is the penalties to which Metlink is subject, which are substantially lower than those for a franchisee breach.

5.5 Termination arrangements

The Government has a strong interest in ensuring that the public transport businesses are equipped with the assets and personnel required to ensure continued operation under a successor franchisee (or the State) after a franchise terminates. The Franchise Agreement contains a range of provisions to ensure that franchises can be efficiently retendered upon expiration, or, in the event of early termination, that the State can take over control of a franchise with no disruption to passenger services. These provisions include:

• Handover Packages – franchisees are required to provide PTD with Handover Packages (updated every six months), which include all information necessary for the State (or a third party) to take over operation of the franchise at short notice. Information provided in the Handover Packages includes details of premises, contracts, systems, daily operations, employees and safety processes;

• restrictions on activities during the “end of franchise” period – the State has powers to ensure franchisees retain staffing levels, manage employee costs and do not expand or reduce the scope of their franchise business’ activities late in the franchise period – eg, by sub-contracting core activities without State consent;

• Direct Agreements – the State has Direct Agreements with key third party suppliers of franchisees, which allow contracts to remain on foot for up to six months after the end of the franchise. In addition, in the case of the Connex franchise, Franchise Entity Direct Agreements with MainCo and AMTL provide for the orderly transfer of employees and assets;

• maintenance of spares – franchisees are required to maintain an adequate supply of critical spare parts for the future, and continue to train drivers;

• Franchise Assets – franchisees are required to make all franchise assets (fixed assets, inventory and contracts) available to the successor operator (or the State) at the termination of the franchise. In the event that a Transfer Agreement cannot be negotiated, the franchisee must transfer assets via an Allocation Statement;

• Primary Franchise Assets – certain assets are designated as Primary Franchise Assets. Franchisees are restricted from selling or disposing of Primary Franchise Assets without the State’s consent, and must replace any that are lost or damaged. This ensures that essential assets which will be required by the public transport businesses in the future are available for the next operators; and

• employee transfer provisions – franchisees must ensure that employees are available for transfer, on fair terms, to a successor franchisee upon franchise termination.

Department of Infrastructure 100 Appendix 1: Financial Summary

COSTS OF OPERATING THE METROPOLITAN PASSENGER RAIL SYSTEM

Nominal $’000 2004/05 to 2008/09

TOTAL TRAIN TRAM Total over Annual %oftotal Total over Annual %oftotal Total over Annual %oftotal period average cost period average cost period average cost

Operating costs: Asset maintenance 1,207 241 29% 908 182 34% 299 60 21% Labour 1,520 304 37% 832 166 31% 688 138 48% NRS lease payments 611 122 15% 437 87 16% 174 35 12% Other (1) 774 155 19% 498 100 19% 276 55 19%

TOTAL OPERATING COSTS 4,113 823 100% 2,675 535 100% 1,438 288 100%

Offset by commercial revenue…

Farebox revenue 1,680 336 41% 840 168 31% 840 168 58% Other revenue 153 31 4% 114 23 4% 39 8 3%

TOTAL REVENUE 1,834 367 45% 954 191 36% 880 176 61%

…and Government payments:

Annual franchise sums (2) 1,428 286 35% 1,164 233 44% 264 53 18% Concession Top-Up 240 48 6% 121 24 5% 119 24 8% NRS lease funding 611 122 15% 437 87 16% 174 35 12%

TOTAL GOVERNMENT PAYMENTS 2,279 456 55% 1,721 344 64% 558 112 39%

METLINK (3) 384 77

Notes:

1. Includes overheads, project expenditure and profit margin. 2. Includes fixed payments, plus performance payments and funding of project expenditure. 3. Excludes franchisee contributions already in operators’ costs (approximately $2 million per operator per annum), and includes approximately $50 million per annum in payments to OneLink Transit for the existing ticketing system.

Department of Infrastructure 101 Department of Infrastructure 102 Appendix 2: Risk Allocation Table

RISK ALLOCATION

NB: This table deals with the allocation of specific contractual risks, not with more generalised factors affecting the risk profile of the franchises, such as levels of Government funding, revenue allocation factors, contract length or exogenous factors such as economic performance.

Key: FA: Franchise Agreement IL: Infrastructure Lease RS Docs: New Rolling Stock documentation MSA: Metlink Services Agreement

Risk category Risk description Allocated to Comment Reference More risk for State?

Financial risks

Cost risks Labour costs Franchisee No change

Asset maintenance costs Franchisee No change

Traction power costs Franchisee No change

Insurance costs State Franchisee self-insures up to defined deductible. State FA Cl 33, Sch 1 More procures insurance policies above deductible. IL Cl 29

Future changes in employee entitlement Shared Scale of liability each year forecast in Franchise FA Sch 14 More liabilities Agreement. Franchisee makes or receives compensating payment for divergence from forecast.

Franchisees not required to pay out liabilities in cash at termination of previous Franchise Agreement.

Department of Infrastructure 103 Risk category Risk description Allocated to Comment Reference More risk for State?

Revenue risks Farebox revenue Shared State shares a defined proportion of “pain” if revenue FA Sch 14 More (downside falls short of annual thresholds defined in Franchise only) Agreement.

Revenue risk “switched off” for defined periods associated with new ticketing system implementation More (upside & and Commonwealth Games. downside)

Pricing State State permitted to claw back revenue windfalls No change associated with above-inflation fare increases which it authorises.

Other revenue Franchisee Respective rights of VicTrack and franchisee (eg, to Less advertising revenues) clarified, reducing risks of disputation.

Financial performance Franchisee losses Franchisee No change

Franchisee overpayment Shared State shares a defined proportion of benefit if profits FA Sch 14 Less exceed annual thresholds defined in Franchise Agreement.

Franchise or Franchise Entity insolvency Shared While State and franchisee both affected, contractual Less arrangements have been tightened to maximise capacity for pro-active response by State.

Supplier insolvency/change of control Franchisee No change

Department of Infrastructure 104 Risk category Risk description Allocated to Comment Reference More risk for State?

Related party matters Franchisee Stronger safeguards have been put in place to prevent Less capital leakage and transfer pricing between Franchise Entities and related parties.

Other Inflation rate State FA Sch 14 No change

Operational risks

Performance Punctuality & reliability Franchisee Franchisee exposed to OPR incentive regime and FA Cl 7, Sch 7, No change potential requirement to compensate passengers for particularly poor performance. FA Cl 8, Ann D

Tram speeds Franchisee Base operating payments reduced if tram speeds FA Sch 14 Less improve above agreed thresholds (eg, as a result of State-funded priority measures).

Safety Accreditation, compliance with regulations Franchisee FA Cl 2, 11 No change

OH&S Franchisee No change

Third party claims Franchisee No change

External parties Industrial relations Franchisee No change

Performance of suppliers Franchisee No change

Capacity Overcrowding Shared Franchisee required to use all reasonable endeavours FA Cl 6, Sch 5 No change to mitigate overcrowding. State obliged to relax standards or fund extra capacity if overcrowding can only be remedied by extra capital investment.

Department of Infrastructure 105 Risk category Risk description Allocated to Comment Reference More risk for State?

Metlink Fulfilment of obligations Franchisee Franchisees indemnify State and TTA for performance FA Cl 7, Cl 34, Less of Metlink. Joint liability capped at $25 million. MSA

Asset risks

Maintenance Infrastructure condition (operability, safety) Franchisee Franchisee must implement works prescribed in Asset IL Cl 7-9 No change Management Plan. Bears full price risk, plus safety/operability risk over term of franchise.

Infrastructure condition (long term) State State bears risk on asset condition beyond franchise No change term.

Vehicle condition (operability, safety) Franchisee Franchisee must satisfy condition indices prescribed in FA Cl 31 No change the Franchise Agreement and must not defer maintenance. Sch 19-24

Vehicle condition (long term) State Provided condition indices are met by franchisee and No change provided there is no maintenance deficit due to franchisee deferral of maintenance, State bears risk on asset condition beyond franchise term.

Risk in relation to the long term condition of new rolling stock is shared between the State and the financier (who carries residual value risk).

Systems (operability) Franchisee Franchisee must develop and implement an IT refresh FA Cl 11 Less and currency program, designed to minimise risks during and after franchise term.

Department of Infrastructure 106 Risk category Risk description Allocated to Comment Reference More risk for State?

Systems (long term) State State bears risk on systems performance beyond Less franchise term.

Projects Franchisee-managed (cost, timing, revenue Franchisee IL Cl 18 No change & operational impacts)

State-managed (cost, timing) State IL Cl 15-17, 20, 34 No change

Sch 4

State-managed (operational, operating cost State Compensation mechanisms refined, with binding FA Cl 7, Sch 7 No change and revenue impacts) determination by independent expert in the event of disputes.

RFR Shared Connex has agreed to caps on any compensation FA Sch 4, Sch 26 Less claims if defined processes are followed by State.

Vehicle procurement Construction cost Other Risk borne by third party supplier. RS docs No change

Timing of delivery Other Risk borne by third party supplier. RS docs No change

Commissioning/introduction Shared Franchisee responsible for ensuring infrastructure is RS docs More operable and industrial relations issues resolved to permit operation.

State shares risk on Siemens trains (up to 31 October 2004 or 400,000 hours of service) with Connex.

Department of Infrastructure 107 Risk category Risk description Allocated to Comment Reference More risk for State?

Operability of vehicles Franchisee/Other Subject to warranties and other undertakings in RS docs No change contracts between franchisees and third party suppliers.

Latent defects Rectification costs Shared Franchisee bears cost of rectification up to $3.5 million. IL Cl 30 More State bears costs thereafter. In refranchising, thresholds reduced for train from $7 million to $3.5 million. Tram unchanged.

Contamination Pre-existing (clean up costs) State IL Cl 23 No change

New (clean up costs) Franchisee IL Cl 23 No change

Environment Compliance with laws & regulations Franchisee IL Cl 24 & 25 No change

Accessibility DDA compliance risks Franchisee Up to 2007, franchisee responsible for complying with FA Cl 8 No change DDA standards (subject to exemptions).

Exemptions State State may terminate Tram Franchise Agreement if key FA Cl 8 No change exemptions not granted.

Other risks

Force majeure State Extended to include catastrophic and unavoidable FA Cl 20 More failure of Metrol (train only), but otherwise minor drafting changes only.

Change in law State Govt law aimed at public transport State Minor drafting changes only. FA Cl 11 No change

Department of Infrastructure 108 Risk category Risk description Allocated to Comment Reference More risk for State?

Other Franchisee FA Cl 11 No change

State-initiated variation State More efficient processes introduced to assess impact FA Cl 38, Sch 4 Less on franchisee and determine levels of compensation where necessary.

Department of Infrastructure 109 SUMMARY: STATE-RETAINED RISKS

RISK NATURE OF RISK ALLOCATED TO STATE UNDER RATIONALE FOR ALLOCATION & MITIGATION FORMER FRANCHISES?

Insurance costs Upside & downside No Rationale: State able to secure better value by procuring insurance on behalf of whole industry rather than leaving to individual operators.

Mitigation: DOI to manage with VMIA. Budget cover (plus contingencies) already allocated.

Employee entitlement liabilities Neutral No Rationale: Original obligation on franchisee to pay out employee entitlements in full at franchise expiry was unsustainable and would have led to significant additional funding requirements.

Mitigation: Franchise Agreement defines expected future scale of liability, with franchisee required to make or receive payments in respect of any variation from forecast.

Revenue risk: downside risk-sharing Downside only No Rationale: Lower risk premiums in franchise payments; reflects limited ability of franchisees to control patronage and revenue; improves franchise sustainability.

Mitigation: Modelling suggests additional risk to the State will be modest; covered in Budget contingencies.

Revenue risk: Commonwealth Games/NTS Upside & downside No Rationale: Lower risk premiums in franchise payments; provides State with free hand to manage implementation without risk of claims for revenue forgone.

Mitigation: State will need to take into account revenue and cost impacts of projects as it plans their implementation.

Revenue risk: State clawback for real fare increases Upside only Yes Rationale: Enables State to reduce cost of franchises by increasing user contribution to cost of public transport operations.

Mitigation: Upside risk only.

Department of Infrastructure 110 Overpayment of franchisee (funding higher than Downside only Yes Mitigation: Profit sharing mechanism now provides safeguard against required) excess profits pursuant to “single source“ negotiation

Franchisee or Franchise Entity insolvency Downside only Yes Rationale: Insolvency intrinsically awkward, given scope for operational disruption and claims from creditors.

Mitigation: $100 million Performance Bonds as security for performance of franchisees’ obligations. While State and franchisee both affected, contractual arrangements have been tightened to maximise capacity for pro-active response by State.

Inflation rate Upside & downside Yes Rationale: Facilitates forecasting by franchisees; lower risk premiums in franchise payments.

Mitigation: Budget contingency already allocated.

Capacity: overcrowding Downside only Yes Rationale: Costs of additional vehicles or infrastructure capacity likely to be prohibitive for franchisee with 5 year contract.

Mitigation: State under no obligation to fund additional capacity if overcrowding occurs. Franchisee required to use all reasonable endeavours to cure overcrowding.

Long term asset condition (infrastructure, vehicles, etc) Upside & downside Yes Rationale: Unavoidable: inherent function of contract length.

Mitigation: Detailed AMPs, RSMPs and ICT strategies must be developed by the franchisee and approved by the State, prior to implementation by the franchisee.

State-managed projects: cost/timing (including New Upside & downside Yes Rationale: State should bear risk on projects which it manages. Ticketing System and Commonwealth Games) Mitigation: State will take into account revenue and cost impacts of projects as it plans their implementation.

Department of Infrastructure 111 State-managed projects: operational, operating cost & Downside only Yes Rationale: Franchisee should not be penalised for disruption caused by revenue impacts State-initiated projects over which it has no control.

Mitigation: State will take into account operational impacts of projects as it plans their implementation. OPR is budget-neutral in any case.

Commissioning/introduction of Siemens trains Downside only Yes Rationale: Connex very reluctant to assume full risks as per original rolling stock supply agreements, given difficulties previously experienced by M>Train and lack on operational track record of Siemens trains at franchise commencement.

Mitigation: State’s exposure capped in terms of timing and vehicle operating hours.

Latent defects Downside only Yes, but more so now Rationale: Franchisee should not bear risk on defects which by definition it could not have anticipated or prevented. Reduces risk premiums in franchise payments.

Mitigation: Franchisee must bear rectification cost up to $3.5 million (to prevent large numbers of claims against the State for trivial defects) and otherwise mitigate impacts.

Pre-existing contamination Downside only Yes Rationale: Franchisee should not bear risk on contamination which by definition it could not have anticipated or prevented.

Mitigation: Costs only arise if Clean-up Notice issued by EPA. Costs managed as part of VicTrack budget.

DDA exemptions Downside only Yes Rationale: Future status of exemptions uncertain. Major cost implications for the industry. Natural role for State Govt in negotiations with Commonwealth. Substantially reduces risk premiums in franchise payments.

Mitigation: For State Government to negotiate with Commonwealth.

Department of Infrastructure 112 Force majeure events Downside only Yes Rationale: Franchisee should not bear risk on events which by definition it could not have anticipated or prevented. Reduces risk premiums in franchise payments and improves franchise sustainability.

Mitigation: Franchisee contractually required to mitigate impacts of force majeure event in order to earn relief from obligations.

Changes in State Government law Upside & downside Yes Rationale: Cannot be managed by franchisee; reduces risk premiums in franchise payments.

Mitigation: Risk clearly manageable by State Government; needs to assess cost implications for industry before introducing laws.

State-initiated contract variations Downside only Yes Rationale: Variations cannot be forecast by franchisee. Reduces risk premiums in franchise payment.

Mitigation: Risk clearly manageable by State Government. Clearer framework mitigates risk.

Department of Infrastructure 113 Department of Infrastructure 114 Appendix 3: Key Projects

A list of key projects under the Infrastructure Leases is provided below. Section 4.6.6 details the delivery mechanism for projects across the rail network.

Train:

Project Description Delivery Automated train monitoring Implementation of a system to provide Franchisee Project (subject system automated recording and accurate to preparation of contract reporting of train arrival and departure by the State) times at locations throughout the metropolitan train network. Burnley to East Camberwell Design, supply and installation of a Franchisee Project signalling upgrade computer-based interlocking system and associated field equipment between Burnley and East Camberwell stations. Car park security project Works to provide secure car parking at up Provisional Franchisee to 10 stations. Project (subject to project scope, but must be implemented) Car park upgrades Completion of improvements to car parks Franchisee Project at: • Frankston Station; • Werribee Station; • Albion Station; • Berwick Station; • Narre Warren Station; and • Huntingdale Station. Connex host stations Improvement of facilities at 31 host Provisional Franchisee stations, including toilets, waiting rooms Project (subject to project and passenger information systems. scope) Craigieburn electrification Electrification of the rail line between Proposed Rail Project (but Broadmeadows and Craigieburn, committed to be delivered) including construction of two new stations, signalling and train stabling. Depot improvements Identification of requirements for train Provisional Franchisee maintenance and stabling, and Project (subject to examination of alternative locations for business case and project facilities, including surrendering Newport scope) Depot. Flinders Street Station Remediation works to strengthen the Proposed Rail Project (but concourse slab structure of the concourse at Flinders committed to be delivered) Street Station. Jolimont Station Improvement works to the layout of Proposed Rail Project (but improvements Jolimont Station in preparation for the committed to be delivered) Commonwealth Games. Loop station signage Works to address any safety issues Provisional Franchisee upgrade identified in relation to signage around Project (subject to project City Loop stations and tunnels. scope)

Department of Infrastructure 115 Narre Warren – Cranbourne Grade separation of the Pakenham rail State Rail Project17 Rd grade separation line at the widening of Narre Warren – Cranbourne Road. New amenities for Connex Modification of existing stations to provide Provisional Franchisee customer service officers a meeting room and necessary amenities Project (subject to project for staff. scope) Parallel bonding Design and installation of a new signalling Provisional Franchisee track circuit bonding arrangement to Project (subject to project minimise the risk of non-detection of scope) trains at turnouts. Rolling stock Concord Changes to Comeng rolling stock to allow Provisional Franchisee project interoperability of the Connex and ex- Projects (subject to project M>Train fleets. This project has three scope, and for phases 2 parts, offering higher levels of integration and 3, a business case) if Connex can provide a convincing business case. Spencer Street Station Redevelopment of the buildings and State Rail Project redevelopment railway infrastructure at Spencer Street Station. Substation upgrades Upgrade of substations at North Franchisee Project Melbourne and Highett, and tiestations at Melbourne Central and Spencer Street. Train management facility Modifications to the train management Provisional Franchisee software modification facility software to an acceptable reliability Project (subject to project project specification, including integration with scope) PRIDE 2. Yarra Precinct pedestrian Construction of a 525m long pedestrian State Rail Project17 link link over the Jolimont rail yards connecting Birrarung Marr park with the MCG.

17 These projects have been declared State Rail Projects under the Infrastructure Leases, notwithstanding that they are not enhancements to the rail infrastructure.

Department of Infrastructure 116 Tram:

Project Description Delivery Destination unit upgrade Replacement of destination blinds on A Provisional Franchisee Class trams with dot matrix indicators (or Project (subject to scope) similar). Docklands Drive tram Extension of the tram line along Harbour Yarra Trams to deliver extension Esplanade and Docklands Drive to outside the Infrastructure Waterfront City. Lease (under a separate Construction Control Deed) East Preston lifting facility Upgrade of East Preston Depot facilities Provisional Franchisee to allow the transition of some heavy Project (subject to scope) maintenance activities from Southbank to East Preston. Information technology Improvements to the IT infrastructure Franchisee Project hardware/software upgrade across the franchise business (in and refresh accordance with obligations in the Franchise Agreement). Melbourne University Reconstruction of tram infrastructure at Provisional Franchisee terminus reconfiguration the Melbourne University terminus to Project (subject to scope) improve tram operations, accessibility and traffic management. Passenger information Development, supply, installation and Franchisee Project displays maintenance of 150 real-time passenger information displays and six electronic trip planners at stops across the tram network. Tram braking upgrade Completion of upgrades to the braking Franchisee Project system of A and B Class trams. Tram driver ventilation Improvements to driver cab ventilation on Provisional Franchisee upgrade AandZ3Classtrams. Project (subject to scope) Tram refurbishments Completion of refurbishment of A, B and Franchisee Project Z3 Class trams. Project includes the Apollo trial – increasing standing room in 10 B Class trams. Tram Travel Time Works to improve the journey times of Proposed Rail Project (but Improvement project trams by removing impediments to their committed to be delivered) running. Vermont South tram Extension of the tram line along Burwood State Rail Project extension Hwy from East Burwood to Vermont South Shopping Centre. Yarra Precinct pedestrian Construction of a 525m long pedestrian State Rail Project17 link link over the Jolimont rail yards connecting Birrarung Marr park with the MCG. Z3 tram overhaul Bogie overhauls on Z3 Class trams. Provisional Franchisee program Project (subject to scope)

Department of Infrastructure 117 Department of Infrastructure 118 Appendix 4: List of Documents

The list of documents provided in this appendix is designed to provide a general overview of the range of documents associated with the Partnership Agreements. Sub-headings and descriptions used are for ease of reference only and may not match the legal definitions of the documents described. The list in this appendix is not intended to be exhaustive.

Transaction Documents

Legally binding documents establishing the structure of the franchised delivery of public transport in Melbourne, and governing the relationship between the State and the franchisees.

1. Franchise Agreements 2. Infrastructure Leases 3. Sale of Assets Agreements 4. M>Train and M>Tram Transfer Agreements 5. Thiess Transfer Agreements 6. Bombardier Transfer Agreement 7. Deeds of Charge 8. Performance Bonds 9. Deeds of Subordination 10. Parent Company Guarantees 11. Parent Company Share Mortgages 12. Franchisee Deeds of Priority 13. Independent Certifier Deeds 14. State Sponsor Support Agreement 15. Return Conditions Agreement

Rolling Stock Supply and Maintenance Agreements

Legally binding documents establishing the ownership, supply, leasing and maintenance of existing and new rolling stock on the train and tram networks.

1. State Rolling Stock Leases 2. State Rolling Stock Head Leases 3. Delivery Assistance Agreements 4. Manufacture and Supply Agreements 5. Committed Rolling Stock Leases 6. Separate Maintenance Agreement 7. Fleet Maintenance Agreements 8. Rolling Stock Procurement Agreement 9. Rolling Stock Maintenance Agreement 10. Yarra Supply Contract (Rolling Stock) 11. Existing Rolling Stock Transfer Deeds 12. Option Rolling Stock Lease 13. ERS Sale and Purchase Agreements 14. ERS Rolling Stock Maintenance Sub-contract 15. Intellectual Property Management Deed

Department of Infrastructure 119 Metlink Documents

Legally binding documents establishing the ownership, governance and funding of Metlink and its relationship with the State and other key stakeholders.

1. Metlink Services Agreement 2. OneLink Management Agreement 3. Revenue Sharing Agreement 4. Metlink Shareholders Agreement 5. Tram Operator Services Agreement 6. Train Operator Services Agreement 7. V/Line Passenger Services Agreement 8. Bus Association of Victoria Services Agreement 9. Metlink Call Option Deeds 10. Metlink Deed of Charge 11. Metlink Trade Mark Licence Deed 12. Constitution of Metlink Victoria Pty Ltd 13. Metlink Entities Sale Agreement 14. Metlink Share Purchase Agreement 15. Metropolitan Rail Services Agreement 16. Metlink Subordination Deed 17. Metlink Subordination Loan Agreement

Connex Franchise Structure Documents

Legally binding documents governing the structure and interaction of the parties which make up the Connex franchise structure.

1. MainCo Shareholders Agreement 2. MainCo Maintenance Agreement 3. Connex Parent Company Guarantees 4. Alstom Parent Company Guarantees 5. State Documents Indemnity Deed

Direct Agreements

Legally binding documents between the State and the franchisees’ key suppliers or contractors in relation to contracts between those suppliers and the franchisee (as shown in brackets).

1. Separate Maintenance Agreement Direct Agreement (relating to AMTL maintenance of new X’trapolis rolling stock) 2. MainCo Maintenance Agreement Direct Agreement (relating to the MainCo Maintenance Agreement) 3. Committed Rolling Stock Supply Direct Agreements 4. Option Rolling Stock Supply Direct Agreement 5. New Rolling Stock Lease Direct Agreements 6. New Rolling Stock Maintenance Direct Agreements (relating to the Siemens maintenance of new rolling stock) 7. Existing Rolling Stock Maintenance Subcontract Direct Agreement (relating to AMTL maintenance of existing rolling stock) 8. Performance Security Recourse Direct Agreement (relating to Alstom Australia’s Performance Bond under the MainCo Maintenance Agreement and Separate Maintenance Agreement) 9. Secondment Direct Agreements (relating to the services of key personnel on secondment to the franchisees from Yarra Trams and Connex parent companies) 10. Key Contract Direct Agreements (with a range of other suppliers of key goods and services)

Department of Infrastructure 120 Interoperator Agreements

Legally binding documents governing the relationship between non-State rail operators and access to infrastructure (parties are shown in brackets for each).

1. Rail Squares Access Agreement (Yarra Trams and Connex) 2. Traction Power Agreement (Yarra Trams and Connex) 3. VRTC Services Agreement (Yarra Trams, Connex and VicTrack) 4. Access Agreement (Connex and V/Line Passenger) 5. Station Agreement (Connex and V/Line Passenger) 6. Services Agreement – Spencer Street Station (Connex and V/Line Passenger) 7. Track Access Agreements (Connex and Hoys Roadlines, West Coast Railway and CountryLink – 3 separate agreements) 8. Rolling Stock Hire and Services Agreement (Connex and V/Line Passenger) 9. Freight Australia Access Agreement (Connex and Freight Australia) 10. Great Southern Railway Access Agreement (Connex and Great Southern Railway) 11. Spencer Street Station Access Agreement (Connex and Civic Nexus) 12. Occupations and Administration Agreement (Connex, Spencer Street Station Authority, Civic Nexus and V/Line Passenger) 13. Services and Development Agreement (Spencer Street Station Authority and Civic Nexus) 14. Operational Control and Signalling Agreement (Connex and Freight Australia) 15. Master Spencer Street Deed (Connex, Director of Public Transport, Spencer Street Station Authority, V/Line Passenger and Great Southern Railway) 16. PTIO Constitution (Yarra Trams, Connex, Bus Association of Victoria, Spencer Street Station Authority, V/Line Passenger and Metlink)

Refranchising Documents

Governed and assisted in the Refranchising Process.

1. Key design principles for franchise contracts (consultation draft) 2. Communications Plan 3. Probity Plan 4. Guidance material for infrastructure management planning (consultation draft) 5. Infrastructure Improvements Regime (consultation draft) 6. Request for Proposals 7. Contract Design Guide 8. Data Room Guide 9. Initial Offer Template and Instructions 10. Asset Management Plan Guidance Material 11. Public Sector Benchmark 12. Evaluation Framework 13. Offer Evaluation Report

Practice Notes

Non-binding guidance documents to provide clarity and assist in the implementation of the arrangements under the Transaction Documents.

1. Business Planning Practice Note 2. DDA Compliance Practice Note 3. Schedule 14 (Payments) Practice Note 4. Franchise Sum Adjustments Practice Note 5. Rolling Stock Methodology Practice Note

Department of Infrastructure 121 6. OPR Target Adjustments Practice Note 7. Timetable Changes Practice Note 8. Breach Penalties Practice Note 9. Form of Asset Register Practice Note 10. Service Growth Incentive Practice Note 11. Metlink Survey Practice Note 12. Metlink Website Practice Note

Franchisee and Metlink Plans

Generally binding documents provided by the franchisee or Metlink pursuant to the Partnership Agreements which detail future strategies or works to be undertaken.

1. Business Plans 2. Asset Management Plans 3. Annual Works Plans 4. Rolling Stock Management Plans 5. Annual Rolling Stock Maintenance Plans 6. Asset Improvement Project Lists 7. System Upkeep Plans 8. Vegetation Management Plans 9. Environmental Management Plans 10. Franchisee’s Action Plans 11. DDA Milestone Plans 12. Forward Capacity Plans 13. Network Marketing Strategy 14. Network Marketing Plan 15. Network Revenue Protection Plan 16. Master Style Guide 17. Metlink Corporate Governance Plan

Miscellaneous Documents

1. Melbourne Central Interface Agreement (governs the interface between Melbourne Central Shopping Centre and the railway station) 2. Construction Control Agreement (governs developers’ access to Melbourne Central for reconstruction of the shopping centre) 3. Construction Control Deed (requires Yarra Trams to construct a tram extension along Docklands Drive) 4. OneLink Service Contract (governs the delivery of automated ticketing and revenue collection services across Melbourne by OneLink) 5. Track Record (a quarterly publication (via the DOI website) produced by PTD showing performance of the Victorian public transport system) 6. Rail Partnerships Guide (an internal PTD document providing a high level reference point for all information associated with the Partnership Agreements) 7. Guide to Connex Franchise Structure (an internal PTD document detailing the structure and operating framework of the Connex franchise business)

Department of Infrastructure 122 Appendix 5: Glossary of Terms

This glossary is provided by way of assistance to people who are unfamiliar with terms used across the rail industry and within this document. The definitions given are not legal definitions and should not be relied upon as such.

Authorised Officer – a person who has been authorised and empowered by the State to enforce compliance with the requirements of the Transport Act. base contract payment – payment by the Government to a franchisee to offset the cost of operating loss-making train/tram services.

BAV (Bus Association of Victoria) – an industry body representing all bus operators across Victoria. bogie – the assembly containing the axles and wheels of a rail vehicle.

Central Pass Office – the body responsible for issuing travel passes to people who are entitled to free public transport.

Completion – the point at which a legal contract takes effect and operations commence.

CPI (Consumer Price Index) – a measure of price inflation in Melbourne, as published by the Australian Bureau of Statistics.

DDA – Commonwealth Disability Discrimination Act 1992 – a federal law under which it is unlawful to discriminate against a person with a disability. deductible – the “excess” on an insurance claim (ie, the amount the insured party must pay in the event of a claim).

Director (the Director of Public Transport) – a statutory officer authorised to enter into public transport contracts on behalf of the State.

DOI (Department of Infrastructure) – the Victorian Government department responsible for providing and managing essential infrastructure, including the public transport system. due diligence – investigations undertaken into a business to ascertain the details of all aspects of its finances and operations to provide a thorough understanding of the business.

Electrol – the facility which contains the supervisory and control equipment used to manage electrical supply to the metropolitan train network.

ERS (existing rolling stock) – rolling stock in use at the commencement of the original franchises in 1999 (W, Z, A and B Class trams, Hitachi and Comeng trains).

Execution – the signing of a legal contract. farebox revenue – revenue from the sale of metropolitan public transport tickets. force majeure – an exceptional event which has a significant impact (eg, natural disasters, wars, acts of terrorism), which a franchisee could not have prevented or foreseen and the consequences of which are beyond the franchisee’s control.

Franchise Entity – a franchisee and other parties which are integral to the delivery of the franchisee’s obligations under the Partnership Agreements.

HREOC (Human Rights and Equal Opportunities Commission) – a statutory federal body which is responsible for (among other things) administering the Disability Discrimination Act and other Acts relating to equality of opportunity.

Department of Infrastructure 123 load standards – prescribed maximum level of acceptable crowding on train/tram services.

Metrol – the facility responsible for managing and controlling train movements throughout the Melbourne metropolitan area.

MPGI (Melbourne Passenger Growth Initiative) – a company formed by all metropolitan franchisees during the original franchising arrangements to manage collective marketing of the public transport system. Now subsumed by Metlink. NRS (new rolling stock) – new rolling stock committed to be purchased as part of the original franchising arrangements (Citadis and Combino trams, X’trapolis and Nexas trains).

Offers – the proposals, including services to be provided and funding required, made by Yarra Trams and Connex to operate the entire tram network and entire metropolitan train network respectively.

OPR (Operational Performance Regime) – an incentive regime which financially rewards a franchisee for operational performance (punctuality and reliability) better than a set target, and penalises it for performance worse than the target. The OPR is described in detail in Section 4.2.1.

Partnership Agreements – generic term for the contractual documents governing the relationship between franchisees and the State, and securing performance by franchisees and other parties involved in the delivery and maintenance of public transport services in Melbourne.

Performance Bond – a financial surety which aims to guarantee a franchisee’s performance of its obligations under its contracts with the State. In the event of the State incurring costs as a result of a default by the franchisee, the State is entitled to draw down on the Performance Bond to cover its costs of remedying the default, up to the value of the Bond.

Practice Note – a (generally non-legally-binding) document which provides clarity and assistance to parties in the form of more detailed explanations of principles and mechanisms for implementing the requirements under the contracts. premium station – a station which is staffed from first to last service every day of the year, and includes an enclosed waiting area, toilets and video surveillance.

PSR (Passenger Service Requirement) – the minimum level of train/tram services required to be operated by a franchisee. The PSR is described in more detail in Section 4.1.1

PTD (Public Transport Division) – the area within the DOI which, among other things, is responsible for overseeing the delivery of public transport services through management of contracts with operators.

RCH (Revenue Clearing House) – the body responsible for the management of collective revenue functions and allocation of farebox revenue during the original franchising arrangements. Now subsumed by Metlink. rolling stock – rail vehicles (ie, trains and trams). route kilometres – length (in kilometres) of train/tram routes. safety zone – a tram stop located between traffic lanes and the tram track, which provides a safe waiting area for passengers through physical separation from road traffic. service kilometres – kilometres travelled by trains/trams providing timetabled passenger service. side letter – legally binding letter between two parties to a contract which forms an adjunct to the contract between them. successor operator – organisation that will run the franchise business after the current franchise ends.

Department of Infrastructure 124 traction power – electricity used to provide power for the operation of rolling stock.

Transport Standards (the Transport Standards for Accessible Public Transport) – minimum standards proclaimed under the DDA which transport operators must meet, including milestones for the achievement of compliance. true-up – a subsequent adjustment made to bring a value into line with what parties expected, where exact values were not available previously.

TTA (Transport Ticketing Authority) – State-owned body responsible for the development and implementation of the new public transport ticketing system.

VicTrip – a body which provided passenger information under the original franchising arrangements, including the operation of a call centre, website and the Met Shop. Now subsumed by Metlink.

Department of Infrastructure 125