Department ofTransport Research Study into the … ofTransport Research Study into the financial and other implications of a proposed restructuring of the CIE companies 22 August 2002

Department of Transport

Research Study into the financial andother implications of a proposedrestructuring of the CIE companies

22 August 2002

22/08/ 02

Department of Transport

Research Study into the financial and other implications of a proposed

restructuring of the CIE companies

22 August 2002

22/08/02 Page 1

TABLE OF CONTENTS

Page

EXECUTIVE SUMMARY 3 - 14 DEFINITIONS 15 1 Introduction 16 - 18 2 Existing Business Structure 19 2.1 Introduction 19 2.2 History of and background to CIE 19 - 22 2.3 Existing industry structure 23 - 24 2.4 Historic financial performance 24 - 26 2.5 Historical financial review of operating companies 26 - 29 2.6 Summary 30 3 Restructuring context 31 3.1 Introduction 32 3.2 Drivers of change 32 - 34 3.3 The model for restructuring 34 - 39 4 Financial Support for Public Service Obligation 40 4.1 Introduction 40 - 41 4.2 Capital grants 41 - 43 4.3 Operational subvention 43 - 44 4.4 Conclusion 45 - 46 5 Property 47 5.1 Introduction 48 5.2 Description 48 - 49 5.3 Issues 49 - 52 5.4 Options 53 - 55 5.5 Conclusion 55 - 56 6 Claims 57 6.1 Introduction 57 - 58 6.2 Issues 58 6.3 Options 58 - 61 6.4 Conclusion 61 7 Debt 62 - 63 7.1 Description 63 - 65 7.2 Issues 65 - 68 7.3 Options 68 - 69 7.4 Conclusion 70

22/08/02 Page 2

TABLE OF CONTENTS

Page

8 Pensions 71 8.1 Description 71 - 72 8.2 Options 72 - 73 8.3 Conclusion 73 9 Other Financial Issues 74 9.1 CIE shareholding in operating companies 74 - 75 9.2 Taxation 75 10 Central Services 76 10.1 Introduction 76 - 77 10.2 Generic restructuring issues 77 10.3 Change management 78 10.4 Operational & management requirements 79 10.5 Resource allocation 79 - 80 10.6 Cost of restructuring 80 - 81 10.7 Generic functional plans 81 10.8 Group IT and Telecoms 81 - 87 10.9 Claims management 87 10.10 Solicitors department 87 - 89 10.11 Property services 89 - 91 10.12 Group finance and treasury 92 - 94 10.13 Internal Audit 94 - 95 10.14 Group human resources and personnel 95 - 97 10.15 Group Secretary 97 - 98 10.16 Group marketing, media and PR 98 - 100 10.17 Programmes and Projects 100 - 101 11 Ancillary Services 102 11.1 CIE Tours 102 - 104 11.2 Commuter Advertising Network 104 - 106 12 Phasing issues for implementation 107 12.1 Introduction 107 12.2 Overall approach to implementation 108 12.3 Stage 1 -“Initial” restructuring 108 - 109 12.4 Stage 2 –“Intermediate” restructuring 110 - 111 12.5 Stage 3 –“Final” restructuring 111 12.6 Restructuring Summary 112 - 114

22/08/02 Page 3

Executive summary

Introduction This report has been written by PricewaterhouseCoopers for the Department of Transport in response to the evolving policy for the development of public transport in Ireland. It seeks to identify issues and set out options for a restructuring of the CIE Group into component operating companies, owned directly by the Minister for Transport (the “Minister”), considering in particular:

• the financial implications of restructuring; • the allocation of assets, debt and pensions, and provision of central group services; and • the making of recommendations for phasing and implementation of restructuring.

The uncertainty surrounding the future development of policy and evolving regulatory framework has immediate impact on the restructuring of CIE. This report assumes a model for restructuring which complies with the broad objectives of Government public transport policy as set out in the Red Book. The model for restructuring achieves independent commercial semi-State operating companies capable of sustained State ownership but with the capability of meeting future policy objectives. While many of the issues may be addressed initially on restructuring there will remain a number that will require greater clarity concerning the regulatory framework and long term policy objectives. Accordingly, we make recommendations for the phasing and implementation of the restructuring process. Existing business structure The CIE Group is currently structured as set out in Figure 1 below.

Government(Department of Public Enterprise)

“DPE”

Coras Iompair Eireann(“CIE parent company”)

IarnrodEireann

“Irish Rail”

Dubel Limited

CIE ToursInternationalIncorporated

“CIET”

Bus Atha Cliath

“Dublin Bus” Bus Eireann

Source: Note 32, Group Annual Report and Financial Statements 2000

CIE Group “CIE”

Government(Department of Transport)

“DoT”

Coras Iompair Eireann(“CIE parent company”)

IarnrodEireann

“Irish Rail”

Dubel Limited

CIE ToursInternationalIncorporated

“Tours”

Bus Atha Cliath


CIE Group “CIE”

Rosslare Harbour

22/08/02 Page 4

Figure 1: Existing CIE Group Structure In addition to holding all of the share capitals of the subsidiary operating companies, CIE parent company currently provides and performs certain functions for CIE Group. It:

• provides a group management function; • owns the property assets; • holds group debt; • negotiates and allocates subvention; and • provides certain central management, administrative and business support services.

Over the past 10 years CIE Group has operated in an environment where services have increased and “single fares” have benefited from infrequent price increases. These increases were not related to extensions of service or cost inflation. As a result of this and operating cost inflation, operating losses before operating subvention has grown from €96m in 1997 to €248m in 2001. In the period since 1999 there has been a significant increase in passenger services available but for many of these services direct operating costs exceed fare box revenues. There has also been extensive investment in fixed assets over the past five years. The existing balance sheet is funded largely with capital grants, debt and claims reserves. Unamortised capital grants have increased from €69m in 1997 to €428m at 31 December 2001. The debt is of a historic nature with net debt of €250m at 31 December 2001 compared to net debt of €278m fourteen years earlier. The cash flow of the CIE Group is not adequate to retire debt and there is no capacity to support debt which is not State guaranteed. In addition, unfunded claims reserves have increased from € 116m in 1997 to €157m at 31 December 2001. As a consequence of the factors described above, a restructuring of CIE Group will be driven, amongst other things, by the treatment of the key areas of property, debt, claims and subvention. Accordingly, the options and consequential impact on the operating companies of restructuring each of these are addressed separately in this report. The operational model is not efficient since the public service obligation is provided at a high level of commitment without detailed specification and lacks performance measurement or incentivisation. In combination with the absence of benchmarked financial objectives there is no tangible process for measurement of value for money for the taxpayer. This is not in accordance with the objective of public transport policy which is to ensure the provision of a defined standard of public transport at reasonable cost to the customer and the taxpayer. The process of restructuring must address these issues. Measurement of financial performance must be considered in an integrated way which addresses:

• the extent of services provided; • farebox policy; • operating subvention; and • capital expenditure plans and available capital grants.

22/08/02 Page 5

Existing funding, subvention and fare box arrangements are not an appropriate basis for sustainable commercial enterprises. Detailed 5 year financial plans are required for each operating entity based on clearly stated assumptions acceptable to the operating companies and DoT. Restructuring context An “optimal” restructuring of the CIE Group in accordance with the broad objectives of public transport policy, should permit the public transport industry to move forward in a manner which will ensure that a defined standard of public transport can be operated efficiently, and performance reported in a manner capable of measuring value for money for the taxpayer. In addition, the restructuring process must maintain sufficient flexibility to be able to accommodate future developments in regulation and policy. A model for the creation of independent sustainable commercial semi-State operating companies (Irish Rail, Bus Éireann and Dublin Bus) should include, amongst other things:

1. a board of directors with an appropriate balance of executive, non-executive and worker directors, responsible to the shareholder, which in future would be the Minister for Transport and not CIE parent company;

2. an independent management team with the depth of resources to address all of the

necessary business functions of an independent entity;

3. a detailed definition of the services to be provided;

4. a detailed definition, in the first instance by the operating companies, of the asset base required to provide those services;

5. the creation by DoT of an efficient funding structure;

6. an independent fares policy which is linked to operating subventions;

7. the setting of financial targets by the DoT with the support of agreed levels of

subvention; and

8. arms-length agreements to be negotiated between the operating companies to deal with access to and use of property, group purchasing and other services provided.

Each of the above items is essential to the creation of stable and sustainable commercial enterprises. It is unlikely that a restructuring of the CIE Group could endeavour to achieve all of the above immediately. The extent to which areas can or should be restructured at each stage is discussed more fully under each of the following sections. Items 1 and 2 need to be addressed in phase 1 while items 3 to 8 must be addressed in phases 2 and 3. Our more detailed recommendations concerning the phasing of implementation are set out in Section 12. Additional personnel resources will be required in the operating companies and in DoT to implement and operate the new regime. Chief Executive appointments in each of the bus companies will be required as the term of employment of the current incumbents expire under the existing appointments in 2003.

22/08/02 Page 6

Financial Support for Public Service Obligation The existing regime for capital grants and revenue subvention is determined through annual budgeting rounds. This constrains long term planning. Increased operational costs resulting from capital projects are not adequately addressed in the determination of operating subvention levels. A review of this process indicates that the following items are required :

1. the development and implementation of a detailed service specification including monitoring and incentivisation mechanisms;

2. the development of an independent fares policy so that the basis of increasing fares

annually provides some commercial freedom to the operating companies and is independent of the Minister of Transport;

3. the introduction of an appropriate legislative and regulatory regime; and

4. the further development of a capital projects evaluation methodology so that cost

benefit analysis takes full account of long term operating costs. Commensurate with item 1 is a commitment from Government to greater certainty concerning future levels of subvention and fares policy to permit longer term planning by the operating companies.

Whilst an optimal restructuring would address all of these, as a minimum it should address options 1, 2 and 4, the implementation of which will be in part dependent on addressing option 3. This would permit an initial drive towards assessment of value for money. Property

The CIE property portfolio is currently held by the CIE parent company which does not charge the operating subsidiaries for use of freehold property. Lease costs are charged on to the operating companies. The depreciated historic cost of this portfolio amounts to €139m at 31 December 2000.

Under any scenario for restructuring the operating companies will require the continued use of operational property. As independent management entities they should be provided with flexibility and incentives to use property in the most efficient manner. The usage, ownership and financing of property should be viewed as separate matters.

There are broadly two options concerning the redeployment of the CIE property portfolio:

• Option 1: transfer the ownership of the operational property from the CIE parent

company to where it is required in each operating company. This may include transfer to an independent entity of property requiring common access, such as bus stops/stations, where ownership may better reside with an independent authority. Any necessary transfers to an independent authority need not happen initially but could

22/08/02 Page 7

happen as and when the regulatory model evolves. We understand that this is the preferred option of operating company management and consistent with recommendations made in the Yellow Book in respect of Iarnrod Éireann’s property.

• Option 2: continue to hold the property in a central property holding entity, which

would offer potential to retain central management, ownership and control. Access to operational property would then be permitted using arms-length lease contracts, incorporating economic rents.

Either of these options can provide a pragmatic solution for property. There are a number of important issues that are required to be resolved before a final decision on property ownership in each operating company is arrived at. These include:

• the nature of the development of a competitive market; • a legal review of EU regulations;

• the nature of regulation for the Irish market place; and

• a legal review of property titles.

Under either option certain constraints should be placed on the use of property to assure preservation of the asset base for public transport use. Clawback arrangements should be put in place to capture any subsequent realisation of surplus value. Whilst constraints might be placed on the primary use of property, consideration should be given to incentivising operators to develop the environment for their customers, including development of peripheral services, such as retail franchises and commercial development. Introduction of an agreed measure for return on capital would provide a driver for further commercial development and exploitation of property assets. Charges should be implemented for use of property by an entity which is not the owner and principal occupier. Claims The CIE Group currently self-insures for all third party and employers’ liability risk, other than catastrophe. Unfunded claims reserves amount to €157m at 31 December 2001. The issues that arise on restructuring are:

• substantial initial funding implications of transferring to third party insurance arrangement and related impact on annual cost;

• legal viability of continuing with self-insurance arrangements in the context of private

investment; and

• the continuation of effective in-house management of the function.

22/08/02 Page 8

The options on restructuring are:

• Option 1: continue with self insurance; • Option 2: establish a direct writing captive insurance company; or

• Option 3: seek third party underwriting.

To enable a restructuring to commence the pragmatic solution is to continue as is with Option 1. This would result in little change to the capital requirements of the CIE Group companies. The companies would continue to avail of the cashflow benefits but equally would be exposed to the risks of under-reserving. The potential would exist to move to either Option 2 or 3 over time if necessary but with very substantial funding requirements. Debt The CIE Group had net debt of €246m at 31 December 2001. CIE parent company is the holder of all group debt and provider of treasury management functions. The group borrowings are guaranteed by the State which permits optimal costs of borrowing. The existing debt funding structure is of a historic nature.

The primary objectives of financial restructuring are two fold being:

• to refinance the CIE Group at sustainable debt levels in the context of its ongoing cashflows and its financing requirements for development and renewals; and

• to establish the operating companies with funding structures that achieve the lowest

weighted average cost of capital.

The issues concerning borrowings on restructuring are:

• there has been no substantial reduction in debt levels since the restructuring in 1987; • any re-allocation of the existing debt to the operating companies on restructuring will

maintain the same level of global borrowings and, assuming continuation of the State guarantee, result in broadly the same global interest charge;

• in advance of a full understanding of the eventual operating environments it is not

possible to determine appropriate levels of gearing for the individual operating companies;

• the ability to service debt will be determined by future cash flows which will be a

function of fares, subvention, service requirements and costs within the evolving regulatory framework;

• the restructuring will lead to an increased cash funding requirement for the CIE Group;

and

• recent losses have further pressurised the debt structure.

22/08/02 Page 9

Prima facie there is no benefit from attempting to re-allocate the existing borrowings. Any desire to have some borrowings allocated to the operating companies in the early phases of restructuring is more closely related to the focus it would provide for management and DoT for operating companies to manage and generate cash.

Accordingly consideration should be given to a capital injection to retire a significant portion of the debt. The debt retirement should be initially focused on Irish Rail where the debt levels have been constant with no reduction in debt levels since the 1987 restructuring. This debt amounted to €171m at 31 December 2001. We recommend full retirement of this debt given there are no current prospects of repaying the debt through operating cash flows.

The bus companies are currently debt free. Consideration should be given to allocating a portion of the debt to the bus companies in conjunction with any transfer of property into these companies. This would effectively force the bus companies to show an economic return on the property transferred into the companies in as much as they would be required to fund the debt. These financing costs would effectively have to be settled either by increased revenues, likely to be fare increases, or through increased operating subvention. This would provide an efficient capital structure and a more transparent financial model but will not necessarily affect group operating performance. The quantum of debt transfer will depend on the 5 year financial forecasts which should be prepared. It will also be essential that the companies be allowed capacity to borrow further amounts to fund ongoing capital expenditure requirements. The residue of debt is at the CIE parent company level. This should be reduced by: (i) the settlement of the LUAS debtor of €47m - this is a timing issue; (ii) the transfer of debt to the bus companies; and (iii) the State retiring the balance. Pensions CIE has two final salary pension schemes both of which are well funded. On restructuring there are broadly two options:

• Option 1: creation and administration of separate pension schemes; or • Option 2: continued shared participation in the existing schemes.

Whilst the operating entities remain in public ownership the advantages of continued shared participation are likely to result in Option 2 being the preferred route for initial restructuring. The advantages of Option 2 are that it will • minimise changes for employees; • save in administration costs; and • avoid splitting up of the funds.

22/08/02 Page 10

Management of Change The management of the change process, leading to any reorganisation of CIE group and its operating subsidiaries, will be fundamentally important to achievement of the desired outcomes. Structured and well planned communication with all the relevant stakeholders will be a critical process. Initial discussion of the planned changes with boards of directors, management, staff and unions will shape the ultimate outcomes. In planning for this change process detailed consideration needs to be given to existing terms and conditions of employment throughout the group. Central Services A number of management, administrative and business support functions are undertaken within the CIE parent company which support the day to day running of the operating companies or are required for consolidation and reporting of group performance to the Department of Transport. The restructuring of the CIE Group should ensure that the board and management teams of each of the operators have sufficient functional resource, systems and administrative support to enable them to continue to manage the business efficiently and effectively as independent commercial entities. To facilitate this a change management process will need to be instigated and managed by a dedicated change team. The change team should include senior management of CIE and each of the operators as well as change specialists. This process will:

• identify the operational and management requirements of the operators; • develop a resource allocation process;

• analyse the cost impact of restructuring; and

• develop a transition plan for the restructuring process.

In developing the restructuring process the CIE Group should seek to retain critical mass efficiencies where possible through shared services arrangements, at least in the short to medium term. This approach is in keeping with best practice adopted by many large national and international businesses. To facilitate the prompt implementation of the restructuring plan we recommend the formation of a Group Services Company to succeed to some of the services currently provided by the parent company. This approach ensures critical mass in certain key areas thus maintaining a value for money approach. The Group Services Company should be proportionately owned by the operating companies. The current functions undertaken by CIE parent company should then either be transferred into the Group Services Company or directly into the operating company as summarised in the table below. We would envisage that the transfer to the operating companies would take place on a phased basis (see description of phasing and Figure 2 on subsequent pages) thus allowing for a smooth transition and ensuring continuity of services to the operating company throughout the period of change.

22/08/02 Page 11

Function Initial Stage Intermediate Stage Final Stage Pensions management (inc. pension payroll) Claims management IT Services Internal Audit

Services to be provided by group services company.

• Strategic review of IT and Internal Audit completed - could be sourced by alternative provider (in-house or outsourced).

• Pensions and Claims management more likely to be maintained as part of GSC at this stage.

As industry structure is developed in more detail, strategic management review of all functions completed and optimal provider for services identified.

Finance & Treasury HR

Current CIE function to be devolved to operators.



Programmes & Projects Group Secretary Marketing & PR Solicitors

• Core functions to be devolved to operators.

• Retention of shared access to specialist expertise during transition period to be assessed further.

All functions devolved to operators.


Property management Further detailed assessment required to determine allocation of management resources based on allocation of property ownership (see p.8).

Further assessment required to determine allocation.


The ultimate objective is to ensure that each operating company has direct control over the support functions throughout the phased process. The phasing also recognises that certain functions such as IT, pensions management, claims management etc., rely on a skill set which is more effectively serviced by a central services function which has the critical mass to provide these services. Accordingly, during the initial phase functions that do not require this particular level of critical mass can be transferred directly into the operating companies. The transfer of other functions is phased to allow each operating company sufficient time to assess the quality and value of services and to develop their own strategy in relation to these more complex functions and either continue to use a central services provider or resource the function internally. The reallocation of the services, currently undertaken by the CIE parent company, to the operating companies will clearly give each operating company more control and direct management of its business. It will, however, lead to some duplication and dis-economies of scale where similar functions are undertaken by individual operating companies: This can be minimised by the continued use of the Group Services Company or an equivalent specialist provider particularly in the areas of IT, pensions and claims. Ancillary Services There are ancillary businesses within the CIE parent company, namely, Tours and CAN. There are two options concerning these assets:

• Two options have been identified for CIE Tours:

22/08/02 Page 12

• Option 1: maintain within State ownership; or

• Option 2: divest the assets through either a management buyout or trade sale

The divestment of this asset offers the potential to generate cash for the CIE Group although it will be essential that analysis to verify the financial viability of this option be undertaken prior to any decision.

• Two options have been identified in relation to the advertising contract managed by

CAN:

- Option 1: Continue with central contract; or - Option 2: Transfer to individual operating company contract.

It is recommended that the existing central contract be maintained until completion. This is because the operating companies will need to complete a review of the benefits of collective negotiation against those of individual operating company management before finalising a decision. Phasing and implementation As indicated above, it is unlikely that the full benefits of restructuring can be achieved simultaneously and that a phased approach to implementation will be required. Accordingly, the following 3 stages of restructuring are envisaged:

• Stage 1: “Initial” restructuring, initial steps to enable a restructuring to commence, albeit at a sub-optimal level. This should commence prior to the introduction of new legislation, which will be necessary to effect the restructuring of the CIE Group.

• Stage 2: “Intermediate” restructuring, which would achieve a sustainable

commercial model in public ownership but maintain flexibility to accommodate future developments in regulation and policy. This would happen on enactment of new legislation and vesting of assets/liabilities in operating companies.

• Stage 3: “Final” restructuring, over time there will be a need to accommodate future

policy developments as envisaged in the Red Book. This would evolve with the implementation of new regulatory regimes. At this stage each of the operating companies would be sustainable commercial enterprises capable of providing a return on a defined asset base.

The outline approach that could be adopted for the restructuring process has been summarised in Figure 2 overleaf. The approach comprises the three stages of restructuring, each preceded by a period of planning and implementation.

22/08/02 Page 13

Figure 2: the restructuring route map

Preparation for Stage 1 “Initial” Restructuring In preparation for Stage 1 “Initial” Restructuring, there are a number of interdependent decisions/approvals required to be taken to enable a detailed restructuring plan to be developed. These are as follows:

(a) a decision by Government to proceed with preparation of necessary legislation; (b) the CIE Group and each operating subsidiary should be requested by Government to

prepare a detailed implementation plan to effect the necessary restructuring; (c) the appropriate assumptions for a 5 year financial plan which include fares policy,

operating subvention, service levels and capital programme should be agreed; (d) the levels of CIE Group debt should be reduced by at least the amount of Irish Rail’s

core debt of approximately €170m; (e) the most appropriate ownership structure for key operational properties in the CIE

Group should be decided - this will involve a legal review of all issues, associated with transfer of operating property within the CIE Group, including title and EU law issues.

Following the above decisions/approvals, detailed planning is required:

(a) to assess the likely medium term impact of restructuring on the global level of subvention and capital expenditure requirements (which are not grant aided);

EnactInitial

legislation

AnnounceRestructuring

Objectives

Introduceregulatoryframework

Competitive &Regulated

environment

Stage 1“Initial stage”

Change Management•Function/operation needs

•Resource allocation, Management & Board

planning

Financial Restructuring•Initial Capital structure

•Investment & cost impact•Debt & property analysis

•5 yr plan

Policy formulation•Subvention process

•Performance measures

Regulation & legislation•Outline Regulatory bodies

•PSO’s•Legislative framework

Stage 2“Intermediate stage”

Change Management•Review central functions

•Implement resource allocation, management &

governance structures

Financial Restructuring•Develop optimal finance

structures•Vest assets/liabilities

•Establish financial targets

Policy formulation•Develop fare regime

•Vfm evaluation

Regulation & legislation•Develop PSC’s•Fully implement

legislation/regulation

Stage 3“final stage”

Change Management•Operationally independent

entities•Review resource &

management

Financial Restructuring•Financially independent

entities

Policy formulation•Review policy objectives

within new operating environment

Regulation & legislation•Complete regulatory &

legislative reforms

EnactInitial

legislation


Objectives



environment




planning



•5 yr plan













•Vfm evaluation






management


entities




legislative reforms

22/08/02 Page 14

(b) to develop initial fares policy, ahead of a formal regulatory regime, to provide the

operating companies with a framework within which to operate; (c) to develop and implement a more detailed service specification which should include

monitoring and incentivisation mechanisms. Commensurate with this will be a commitment from Government to greater certainty concerning future levels of subvention to permit longer term planning by the operating companies;

(d) to commence a change management process including detailed assessment of each

functional area of the CIE Group Services and resource requirements of each operating company;

(e) to prepare 5 year financial plans including cashflow projections, so that an initial view

may be taken concerning the capacity of each operating entity for debt funding and their requirement for working capital facilities.

At the commencement of the initial restructuring the following key steps need to be undertaken:

• appointment of change managers in CIE parent company and in each of the operating companies;

• development of an outline restructuring plan for both the holding company and the

operating companies. These outline plans will require approval by the respective company executive teams, boards and the Department of Transport; and

• development of a communication plan of the restructuring to all key stakeholders.

22/08/02 Page 15

Definitions

“CAN” Commuter Advertising Network, a division of CIE parent company

“CIE Group or “CIE” Córas Iompair Éireann and its subsidiary

companies “CIE operating companies” Irish Rail, Bus Éireann and Dublin Bus “CIE parent company” Córas Iompair Éireann group holding company “DoT” Department of Transport “Irish Rail” Iarnród Éireann “Bus Éireann” Bus Éireann “Dublin Bus” Bus Atha Cliath “CIE Tours” CIE Tours International Incorporated “National Development Plan” or “NDP” The National Development Plan 2000-2006 “The Minister” The Minister for Transport “Red Book” A New Institutional & Regulatory Framework for

Public Transport August 2000 “Yellow Book” Iarnród Éireann, - The Way Forward, A report to

the Minister for Transport, July 2001 “Blue Book” New Institutional Arrangements for Land Use and

Transport in the Greater Dublin Area. March 2001 “PSC” Public Service Contract “PSO” Public Service Obligation “PSR” Public Service Regime “PMS” Performance Measurement System “PTFP” Public Transport Partnership Forum

22/08/02 Page 16

1 Introduction 1.1.1 The economic growth and prosperity that Ireland has experienced over the last 10 years

has resulted in considerable pressure on many aspects of the publicly provided transport infrastructure and services. Expectations of service quality and performance have also increased. In addition there is strong recognition that the role of public transport should also be to promote sustainable development and social inclusion. In recognition of this, the Government introduced the National Development Plan, which outlines proposals for public transport investment strategy for the period 2000 to 2006. This strategy is developed further in “A Platform for Change” an integrated transportation strategy for the Greater Dublin Area 2000 to 2016 published by Dublin Transportation Office in November 2001 and in other land use and transportation strategies being developed in other major cities.

1.1.2 In August 2000, DoT issued the Red Book to outline proposals for new public transport policy. This had two purposes:

• to provide a basis for consultation with interested parties (including the Public Transport Partnership Forum); and

• to provide a policy framework to guide the DoT in preparing the necessary legislative and other measures to give effect to the proposed reforms.

1.1.3 Public transport service provision in Ireland is primarily provided by CIE through its

operating subsidiaries, Irish Rail, Dublin Bus and Bus Éireann. A number of implementation issues associated with the proposed framework were identified in the Red Book and PricewaterhouseCoopers were commissioned to undertake a technical study to assess these issues.

1.1.4 Our Terms of Reference require us to:

• conduct an analysis of the existing and projected financial position of the CIE holding company and its subsidiaries and a description of the financial restructuring required to establish the operating companies as independent entities;

• evaluate the issues likely to arise on the separation of the operating companies from the existing group structure including, inter alia, the allocation of assets and debt, arrangements for pensions, the future provision of services provided by the holding company at present i.e. CIE Group financial management, IT and legal services, property and insurance/liability management; and

• make recommendations on how the financial, management and administrative issues identified might best be addressed and the steps required (including possible phasing arrangements) to implement the restructuring process, taking into account the evolving regulatory framework.

Source: DoT, Appointment of consultants to carry out a research study into the financial and other implications of a proposed restructuring of the CIE companies, May 2001.

22/08/02 Page 17

1.1.5 As referred to above, the National Development Plan and “A Platform for Change” set out public transport investment strategy and a number of consultative documents have been produced in relation to this (including the Red Book and the Blue Book) concerned with the development of institutional, administrative and regulatory reform. This consultation process will promote the formation of policy. At present there is considerable uncertainty concerning the eventual form of that policy. When determined, the policy will have a direct influence on the regulatory framework and operating environment within which Irish Rail, Dublin Bus and Bus Éireann will provide services.

1.1.6 Against this background, CIE parent company and its operating companies are currently constrained in determining their long term business strategy and in long term financial planning. Accordingly, in addressing the Terms of Reference for the report we have carried out an analysis of the financial position of CIE Group but our analysis has been confined to the review of historic financial information and review of the budget for 2002. The operating companies in the CIE Group are responding in a short term framework to significant increases in demand for services and need for extensive expansionary and replacement investment without an integrated and well founded financial plan. While progress has been made in the short term at an operational level a sustainable funding model must be developed.

1.1.7 The uncertainty surrounding the future development of policy and evolving regulatory framework also creates added difficulty for key issues relating to restructuring of CIE. In order to write this report we have had to make a number of assumptions based on the broader objectives of Government public transport policy as set out in the Red Book. These assumptions concern the definition of a model for restructuring which achieves independent commercial semi-State operating companies capable of sustained ownership within the public sector but which should be capable of accommodating future policy objectives concerning:

• the introduction of further competition to markets; • State funding; • introduction of private sector finance; • passing of assets and risk to the private sector; and • maximisation of value of assets.

1.1.8 It will then be possible to make more specific recommendations on how to make

further changes to the operating businesses and regulatory framework to achieve them.

1.1.9 In order to complete the research study we have undertaken a wide ranging analysis of CIE and its subsidiaries. The study has included considerable consultation with the senior management of both the CIE parent company and subsidiary companies. Our approach to the study has been to collate data using meetings and interviews with key personnel to identify issues. PricewaterhouseCoopers has not independently checked or verified this information and we rely on the accuracy and completeness of the information supplied to us.

22/08/02 Page 18

1.1.10 For each of the key areas of restructuring, subvention, property, claims, debt, pensions, and central services, we have applied an approach of describing the topic, identifying issues related to restructuring and setting out the options that may be considered. We have indicated how these issues might be best addressed, setting out the consequences of relevant options. Further detailed work will be required to finalise decisions on the most appropriate option for each issue and the programme of work to lead to implementation.

1.1.11 While many of the issues may be addressed initially on restructuring there will remain a number that will require greater clarity concerning the regulatory framework and long term policy objectives. Accordingly, at the end of the report we make recommendations for the phasing and implementation of the restructuring process.

22/08/02 Page 19

2 Existing Business Structure

Key Points • CIE parent company provides and performs certain functions for the group. It:

- provides a group management function; - owns the property assets; - holds group debt; - negotiates and allocates subvention; and - provides certain central management, administrative and business support

services. • The CIE Group’s current funding model is not sustainable due to lack of clarity in

key planning assumptions. Clearly stated assumptions acceptable to the operating companies and DoT need to be developed in order that detailed 5 year financial plans can be produced for each operating company.

• As a consequence of the above, a restructuring of CIE Group will be driven, amongst other things, by the treatment of the key areas of debt, property, claims and subvention. Accordingly, the options and consequential impact on the operating companies of restructuring each of these are addressed in this report.

• The existing financial model has a debt funding structure based largely on pre 1987 borrowing rather than financial optimisation.

• The operational model is not efficient since the service obligation is provided at a macro level of commitment without detailed specification and lacks a performance measurement or incentivisation mechanism.

• In combination with the absence of benchmarked financial objectives there is no tangible process for measurement of value for money for the taxpayer.

2.1 Introduction

2.1.1 The purpose of this section is to set out the existing business structure, highlighting certain aspects relevant to this study. These relate specifically to the legal, operational and financial structure, and the way in which the business is currently funded. In the face of a number of choices concerning aspects of restructuring this starting point is fundamental.

2.2 History of and background to CIE

2.2.1 CIE is a statutory body providing land based public transport within the Republic of Ireland. It is wholly owned by the Minister for Transport and reports to that Minister. Whilst the operations of CIE were formed over half a century ago, the current structure with three operating companies, was established in 1987 under the terms of the Transport (Re-organisation of Coras Iompair Éireann) Act, 1986. Irish Rail, Dublin Bus and Bus Éireann are incorporated, and operate principally in the Republic of Ireland. They are incorporated under the provisions of the Companies Acts, 1963 to 2001, as wholly owned subsidiaries of CIE in accordance with Section 6 of the Transport (Re-organisation of Coras Iompair Éireann) Act, 1986. The structure of CIE is indicated in the diagram below.

22/08/02 Page 20

Córas Iompair Éireann Group "CIE Group", is organised into the following legal entities: (a) CIE parent company

(b) 3 operating companies – Bus Éireann, Bus Atha Cliath, Iarnrod Éireann

(c) CIE Tours International Inc.

(d) Dubel Limited

(e) Rosslare Harbour

Figure 2.1: CIE Group Existing Structure

2.2.2 CIE parent company is governed under the Transport Act, 1950 (as amended). In addition to its role as group holding company with overall responsibility for the direction, performance and reporting of the Group, CIE parent company also performs a number of other functions:

(a) owner of the portfolio of operational and other properties used by the operating subsidiaries;

(b) holder of the group debt; and

(c) responsibility for the negotiation and allocation of subsidy.

Government

“DPE”

Coras Iompair Eireann (“CIE parent company”)

Iarnrod Eireann

“Irish Rail”

Dubel Limited

CIE Tours Internation al Incorporated

“CIET”

Bus Atha Cliath


Source: Note 32, Group Annual Report and Financial Statements 2000

CIE Group “CIE”

Government (Department of Transport)

“DoT”

Coras Iompair Éireann (“CIE parent company”)

Iarnrod Eireann

“Irish Rail”

Dubel Limited

CIE Tours International Incorporated

“Tours”

Bus Atha Cliath


CIE Group “CIE”

Rosslare Harbour

22/08/02 Page 21

2.2.3 The CIE parent company has some 187 employees whose principal focus is as provider of the following central group services:

(a) IT (Section 10.8)

(b) Claims management (Section 10.9)

(c) Solicitors Department (Section 10.10)

(d) Property Services (Section 10.11)

(e) Group finance & Treasury (including salary and pensions management) (Section 10.12)

(f) Internal Audit (Section 10.13)

(g) Group HR and personnel (Section 10.14)

(h) Group Secretary (Section 10.15)

(i) Group Marketing, media and PR (Section 10.16)

(j) Programmes & Projects (Section 10.17)

2.2.4 Further detail and issues relating to these functions are dealt with in Section 10.

2.2.5 The three key operating companies Irish Rail, Bus Éireann and Dublin Bus and their operating brands, may be summarised as follows:

2.2.6 Iarnród Éireann (“Irish Rail”), a corporate entity with 100% of its share capital held by CIE. The principal activities of Irish Rail are the provision of national rail passenger and freight services. These can be subdivided as follows:

- InterCity - Suburban - Long Distance Commuter - Rail Freight

2.2.7 In addition to these services, Irish Rail also has responsibility for the following

activities:

- Road Freight - Rosslare Harbour - Network Catering including Dubel Limited a corporate entity with 100% of its

share capital held by Irish Rail. (Incorporated in Northern Ireland where it provides catering services for Northern Ireland Railways including their cross-border trains).

22/08/02 Page 22

2.2.8 Bus Éireann, a corporate entity with 100% of its share capital held by CIE. The

principal activities of Bus Éireann are:

- Expressway scheduled inter-urban coach services - Provincial City Services (in Cork, Limerick, Galway and Waterford) - School Bus Services on behalf of the Department of Education and Science - Local stage carriage bus services throughout the country - Commercial Vehicle Testing - Private Hire

2.2.9 Bus Atha Cliath (“Dublin Bus”) a corporate entity 100% of its share capital held by

CIE. The principal activities of Dublin Bus are provision of a comprehensive bus service for the city and county of Dublin and its hinterland as follows:

- City Services - Cityswift - City Speed - City Imp - Nitelink - Airlink - Private Hire

2.2.10 CIE parent company has one further subsidiary:

- CIE Tours International, a corporate entity with 100% of its share capital held by CIE, incorporated in the USA.

2.2.11 The responsibilities of the directors of the subsidiary companies are determined by

company law and the Transport (Re-organisation of Coras Iompair Éireann) Act, 1986. 2.2.12 Rosslare Harbour

The management of the harbour is undertaken by Irish Rail. The ownership and activities of Rosslare Harbour are governed by statute. A legal review is currently being undertaken modernise the status of legislation governing the port which dates back to the 1890s. Rosslare Harbour has been a significant profit contributor with operating profit of €3.8m on turnover of €10m in 2000. A reduction in volumes primarily due to the foot and mouth outbreak in 2001 combined with a competitive market place has reduced operating profit to €2.6m in 2001.

22/08/02 Page 23

2.3 Existing industry structure

Operational structure 2.3.1 The formal line of communication with Government as shareholder is through the DoT

directly to CIE parent company. Strategic direction, control and overall co-ordination is provided by the holding company whilst each subsidiary and business unit has a high degree of operating autonomy. Each of the operating companies has a board of directors which includes worker directors and non-executive directors. The obligation on CIE to provide public transport services, is set out in the 1950 Act, Section 15 and the 1986 Act Section 8 (10), and is substantially based on the existing network timetable. There are no public service contracts in place due to legislative constraints. Some progress has been made with DoT in developing key performance indicators for financial, operational and customer service measures. We understand that a formal performance measurement system to measure and incentivise agreed levels of performance is being developed.

DoT and the CIE Group are working towards a more modern model of transport delivery based on quantifiable service and quality definition. While a three year multi-annual capital budget is used as a planning tool, the annual operational subvention levels are inadequate for current levels of service provided.

Financial structure 2.3.2 CIE Group receives income/funding from four principal sources:

(a) revenue, which is represented substantially by farebox revenue for the provision of bus and rail services but also includes road freight, Rosslare Harbour, catering services etc;

(b) contractors revenue from the Department of Education for school bus contracts and the Department of Social Family and Community Affairs;

(c) operational subvention payments from Government to fund the shortfall of farebox and contract revenues over operating costs; and

(d) capital grants from Government and the EU which are provided in accordance with the relevant EU Regulations governing State Aid to transport undertakings.

22/08/02 Page 24

2.3.3. The movement of revenue between Government and CIE Group is shown in Figure 2.2 below.

Figure 2.2: Revenue movement

2.3.4 Subvention is negotiated on an annual basis as part of a three year rolling process and paid by DoT to CIE Group with CIE parent company assuming responsibility for the allocation of subsidy between the operating companies. The annual process of subvention negotiation is driven by cashflow requirements to achieve a “surplus for the year after State grants”. It is not driven by specified levels of return on capital employed nor at a level that could permit a benchmarking of financial returns against other operators. The current subvention process is assessed in more detail in Section 4. DoT are working on developing a model having regard to international practice.

2.4 Historic financial performance

Introduction 2.4.1 We have completed an analysis of the historical financial position of CIE and the

operators and a summary is presented in this section. More detailed analysis on specific elements has been completed in the relevant sections of this report.

Payment of replacement reserve

Interest

CIE

Dept Financ

Governme

FareboRevenu

Dept of PE

Payment of Net assets

debt claims grants

NB no share capital

Interest

CIE

Dept of Finance

GovernmeGovernment

Farebox Revenue

Dept ofTransport

€(11)m€187m€245m

€481m

Capital Grants Operating subvention

Passenger revenues

Interest Payment

2001Source

22/08/02 Page 25

2.4.2 CIE Group Historic Financial Performance CIE Group 2001 2000 1999 1998 1997 €'000 €'000 €'000 €'000 €'000 Operating Revenue 529,838 484,576 458,977 440,932 423,837Parent company Revenue 18,589 18,193 17,500 13,952 9,397Total revenue 548,427 502,769 476,477 454,884 433,234Group Operating Cost 796,009 -673,522 -569,729 -546,933 -529,232

Operating Loss before Subvention -247,582 -

170,753 -93,252 -92,049 -95,998Subvention 245,122 204,077 146,680 135,862 133,196Operating (Loss)/Profit after Subvention -2,460 33,324 53,428 43,813 37,198 Balance Sheet 2001 2000 1999 1998 1997 €'000 €'000 €'000 €'000 €'000 Fixed Assets 939,561 860,706 737,276 622,994 576,627Net Current Assets 62,937 42,267 67,420 -52,910 -62,914Long Term Creditors -403,833 -357,966 -286,586 -112,023 -99,310Debt -245,693 -194,679 -199,035 -188,127 -187,166Third Party claims/Liabilities -157,232 -146,751 -137,367 -128,060 -116,011 Shareholders Funds -195,740 -203,577 -181,708 -141,874 -111,226 The table above shows that, in response to general economic growth, travel demand in Ireland and consequent expansions of services, revenue has been increasing over recent years with minimal price increases. The increased service provision also resulted in a significant increase in operating costs, and in order to maintain a net surplus for the year (after State grants) subvention levels have increased by over 84% over last 5 years. 2.4.3 In reviewing the financial summaries of both the CIE Group and operating companies

below a number of key points can be identified:

(a) turnover has grown in each of the operating companies by between 18% and 38% in total over the 5 year period 1997 to 2001. This turnover growth is substantially volume related, as there has only been a “single fare” price increase in 2000;

(b) operating costs have increased quicker than revenues (between 45% and 56% over 5 years) resulting in substantial increases in operating loss before subvention. These increases are particularly significant in 2000 and 2001. The increases in costs are primarily due to increases in service levels, pay awards and asset depreciation;

22/08/02 Page 26

(c) In the absence of regular fare box increases, in line with cost inflation, over the period, the companies have relied on subventions to fund operations. Operating subvention has increased by 84% to €245m from €133m in the 5 years to 2001. Operating subvention equates to 45% of revenues in 2001 (31% in 1997).

(d) The CIE Group reported an operating loss after subvention of €2.4m in 2001 and is budgeted to incur an operating loss after subvention of €34.5m in 2002 based on an assumed subvention level of €233m.

(e) There has been a significant capital expenditure increase during 1999 to 2001. The CIE Group does not have the capacity to finance expansionary capital expenditures and has to rely on substantial funding from capital grants. Timing mismatches between expenditure and grant receipts have resulted in cash outflows in some years such as 2001. Unamortised capital grants, have increases from €69m in 1997 to €428 m at 31 December 2001.

(f) The CIE Group has net debt of €246m at 31 December 2001 which is State guaranteed and which is not capable of being repaid from current operational cash flow. In addition the Group self insures for third party and employers liability claims. Claims liabilities stood at €157m at 31 December 2001.

(g) The CIE Group does not have a sustainable funding structure. The funding of the group must be addressed in an integrated way in order to establish sustainable stand-alone commercial semi-State companies. The funding arrangements need to deal with:

• extent of services to be provided;

• farebox policy;

• operating subvention over a rolling three year period;

• capital expenditure plans and available capital grants;

• existing hardcore debt which cannot be repaid from cashflow; and

• borrowing capacity for replacement capital requirements.

2.5 Historical financial review of operating companies

Set out below is a financial summary of the profit and loss, cash flow and balance sheets for the three operating companies for the years 1997 to 2001. The financial summaries are taken from the audited statutory accounts for the years 1997 to 2000, and the draft statutory accounts for 2001. The analysis should be read in conjunction with a review of the full set of financial statements.

22/08/02 Page 27

2.5.1 Irish Rail – financial summary

€ € € € € 2001 2000 1999 1998 1997 '000 '000 '000 '000 '000Turnover Total revenue 197,088 181,597 180,662 173,461 163,829Operating Cost -361,690 -313,293 -311,115 -270,967 -263,286Operating Loss before Subvention -164,602 -131,696 -130,453 -97,506 -99,457Subvention 168,937 147,131 156,293 117,457 117,324Operating Profit after Subvention 4,335 15,435 25,840 19,951 17,867 Cashflow Operating Cash Flow before Sub -153,784 -100,116 -136,599 -73,085 -57,308Subvention 164,118 141,314 150,580 110,220 109,197Operating Cash Flow after Sub 10,334 41,198 13,981 37,135 51,889

Servicing of finance -6,702 -6,870 6,966 7,099 7,413Capital Net Additions/disposals during the year -201,385 -199,885 -69,912 -38,966 -36,431Capital Grant received 148,485 199,382 70,015 23,729 13,072 -52,900 -503 139 -15,237 -23,359Financing -3,891 -3,824 3,489 2,853 2,635 Cash Inflow/(outflow) before Intergroup cash movement

-49,268 33,825 7,154 14,799 21,117

Movement in amount with Holding company and lease financing

42,339 -42,443 -7,147 -15,787 -17,747

Net cash Inflow (outflow) during the year -6,929 -8,618 7 -988 3,370Balance Sheet Fixed Assets 531,437 493,999 451,659 396,168 377,884Net Current Assets 62,719 40,134 69,301 -33,388 -35,865Long Term Creditors -282,232 -266,479 -225,969 -91,792 -80,771Debt -170,617 -121,352 -155,175 -162,329 -177,127Third Party Claims/Liabilities -55,375 -53,193 -49,446 -46,827 -41,802Shareholders Funds -85,932 -93,109 -90,370 -61,832 -42,319

(a) Revenue increased for the years 1997 to 1999 resulting in a reduced operating loss before subvention. Results in 2000 were substantially impacted by industrial action that cost Irish Rail an estimated €19m. In addition to this the implementation of Financial Reporting Standard 15 (which deals with “accounting for tangible fixed assets”) added a further €25m depreciation cost. As a result operating loss before subvention increased by €83m between 1999 and 2001.

(b) This operating loss is reflected in the cash flow that for 2001 shows a substantial reduction on 2000. Cash flow is further pressurised by timing issues in receipt of EU grants for €46.5m of capital work undertaken in 2001.

(c) Significant movements in the balance sheet include the substantial build up of deferred income which reflects unamortised grants. Third party employer liability claims have also risen from 1997 to 2001 reflecting normal timing issues in the settlement of claims.

(d) Net debt has remained at a reasonably constant level throughout the period.

22/08/02 Page 28

2.5.2 Dublin Bus – financial summary

2001 2000 1999 1998 1997 €'000 €'000 €'000 €'000 €'000Turnover Total revenue 153,386 143,292 136,389 133,484 130,191Operating Cost -204,211 -175,356 -149,381 -141,980 -136,330Operating Loss before Subvention -50,825 -32,064 -12,992 -8,496 -6,139Subvention 52,377 41,189 16,816 11,294 8,888Operating Profit after Subvention 1,552 9,125 3,824 2,798 2,749 Cashflow Operating cash Flow before Subvention -24,533 -8,048 3,878 6,953 6,633Subvention 52,377 41,189 16,816 11,294 8,888Operating Cashflow after Subvention 27,844 33,141 20,694 18,247 15,521 Capital Net Additions/disposals during the year -21,500 -56,397 -48,912 -13,261 -16,507Capital Grant Received 24,017 27,298 28,394 136 -70 2,517 -29,099 -20,518 -13,125 -16,577 Cash Inflow/(outflow) before Intergroup cash movement 30,267 4,354 -100 4,784 -1,489Movement in amount with Holding company and lease financing

-29,412 -4,645 1,789 -5,514 2,128

Net cash Inflow (outflow) during the year 855 -291 1,689 -1,798 639 Balance Sheet Fixed Assets 140,234 143,569 109,920 77,223 75,841Net Current Assets/(liabilities) -22,229 -2,094 2,890 -9,545 -11,452Long Term Creditors -56,783 -57,496 -37,235 -547 -251Cash/(debt) 35,714 5,447 1,093 1,194 -3,591Third Party Claims/Liabilities -69,373 -63,009 -59,285 -54,257 -48,941Shareholders Funds -27,563 -26,417 -17,383 -14,068 -11,606

(a) Revenue has increased from 1997 to 2001 by 18% arising principally from increased services. However, operating costs increases of 50% over the 5 years have exceeded this, resulting in a substantial increase in the operating loss before subvention. This has increased from €6m in 1997 to €50.8m in 2001. Increased losses are due to increased services on routes where fares do not meet running costs, wage increases and congestion related cost increases.

(b) The operating loss is reflected in negative cashflow in 2000 and 2001.

(c) As with the other operating companies the inter company balance shows a substantial increase in 2001 reflecting the positive cash generated by the receipt of grants during the year. Third party employer liability claims also show substantial increases over the period 1997 to 2001.

22/08/02 Page 29

2.5.3 Bus Éireann – financial summary

2001 2000 1999 1998 1997 €'000 €'000 €'000 €'000 €'000Turnover Total revenue 179,364 159,687 141,926 133,987 129,817Operating Cost -207,515 -170,056 -144,788 -136,024 -132,657Operating Loss before Subvention -28,151 -10,369 -2,862 -2,037 -2,840Subvention 23,808 15,758 7,377 7,111 6,984Operating Loss after Subvention -4,343 5,389 4,515 5,074 4,144 Cashflow Operating Cash Flow before Subvention -27,078 -6,989 5,149 8,261 6,854Subvention 23,808 15,757 7,377 7,111 6,984Operating Cash Flow after Subvention 3,270 8,768 12,526 15,372 13,838 Capital Net Additions/disposals during the year -24,099 -35,322 -4,511 -11,236 -11,772Capital Grant Received (Commuting Services) 17,270 6,478 0 0 0 -6,829 -28,844 -4,511 -11,236 -11,772Cash Inflow/(outflow) before Intergroup cash movement

-2,577 -19,362 8,169 4,110 2,218

Movement in amount with Holding company 3,087 22,511 -11,358 4,453 1,665Net cash Inflow (outflow) during the year 510 3,149 -3,189 8,563 3,883 Balance Sheet Fixed Assets 85,014 74,205 48,249 51,930 49,032Revised Net Current Assets -319 -4,738 -9,281 -7,843 -9,857Revised Long Term Creditors -21,072 -6,162 -2,872 -6,450 -4,793Debt 2,266 4,790 24,205 16,036 11,925Third Party Claims/Liabilities -32,484 -30,329 -28,636 -26,978 -25,268Shareholders Funds -33,405 -37,766 -31,665 -26,695 -21,039

(a) As with Dublin Bus and Irish Rail, Bus Éireann revenue has increased significantly between 1997 and 2001 (38% in total) arising principally from increased services with only a single price increase during the same period. However operating costs have increased at a higher rate, (56% over 5 years) resulting in significant increases in operating losses. Whilst this has historically been covered by subvention, Bus Éireann will disclose an operating loss after subvention of approximately €4m in 2001. This loss after subvention is expected to increase in 2002. These increasing losses are due to increased services on commuter routes where fares do not meet running costs, wage increases and congestion related cost increases.

(b) Bus Éireann has also incurred significant cash outflows on investing in a new fleet in the years 2000 and 2001. New vehicles added to the fleet have been grant funded, whilst operating cash flow has funded replacement of existing fleet.

22/08/02 Page 30

2.6 Summary The CIE Group is becoming increasingly reliant on larger operating subventions.

Furthermore it currently does not have the financial capacity to fund its capital investment programme. Under existing funding arrangements there are no prospects of repaying existing debt and there is no capacity to support debt which is not State guaranteed.

Conclusions Detailed financial plans for each operating company need to be prepared for the next 5

year period. The plans must address the increasing expectation for levels of service delivery and deal with the implications this has on the key cost drivers. Inherent in the plan will be the assumption of fare box pricing and whether regular price increases can be provided for. This operating financial plan should be prepared in conjunction with a capital expenditure plan.

These operational and capital plans will indicate the level of subvention required to

fund the operations and the extent to which operating companies can fund their capital expenditure requirements. As mentioned in the subvention section of this report Section 4 subventions levels will need to be linked to activity levels and fares policy to allow a transparent and value for money methodology. Key issues to be dealt in the subvention model must include a strategy for capital expenditure/replacement going forward and how to address debt financing and retirement.

22/08/02 Page 31

3 Restructuring context

Key Points • An “optimal” restructuring of CIE should permit the operators to move forward in a

manner that permits services to be operated efficiently demonstrating value for money for the taxpayer. In addition, the restructuring process must preserve sufficient flexibility to accommodate future developments in regulation and policy. Such an “optimal” model should include, inter alia:

1. a board of directors with an appropriate balance of executive, non-executive and

worker directors, responsible to the shareholder, which in future would be the Minister for Transport and not CIE parent company;

2. an independent management team with the depth of resources to address all of

the necessary business functions of an independent entity;

3. a detailed definition of the services to be provided;

4. a detailed definition, in the first instance by the operating companies, of the asset base required to provide those services;

5. the creation by DoT of an efficient funding structure;

6. an independent fares policy which is linked to operating subventions;

7. the setting of financial targets by the DoT with the support of agreed levels of

subvention; and

8. arms-length agreements to be negotiated between operating companies to deal with access to property, group purchasing and other services.

• Each of the above items is essential to the creation of stable and sustainable

commercial enterprises. It is unlikely that a restructuring of the CIE Group could endeavour to achieve all of the above immediately. The extent to which areas can or should be restructured at each stage is discussed more fully under each of the following sections. Items 1 and 2 need to be addressed in phase 1 while items 3 to 8 must be addressed in phases 2 and 3. Our more detailed recommendations concerning the phasing of implementation are set out in Section 12.

• Additional personnel resources will be required in the operating companies and in

DoT to implement and operate the new regime. Chief Executive appointments in each of the bus companies will be required as the terms of employment of the current incumbents expire under the existing appointments in 2003.

22/08/02 Page 32

3.1 Introduction

3.1.1 The restructuring of CIE is being driven by a number of factors:

- increased travel demand; - Government policy and objectives; and

- a changing regulatory environment as envisaged in the Red and Blue Books.

3.1.2 The eventual position concerning certain of these factors is and is likely to remain

uncertain for some time as Government policy is still subject to consultation. Accordingly, in writing this report we have set out a number of assumptions within which the options for restructuring may be reviewed. Importantly, the eventual plans for restructuring should permit the industry to move forward in a flexible way so that it always remains compliant with the drivers of change. The phasing of restructuring is addressed in Section 12 of this report.

3.2 Drivers of change

Response to increasing demand 3.2.1 Economic prosperity in Ireland over the last decade has resulted in increased demand

for public transport services and together they have put tremendous pressure on the country’s infrastructure. Dublin and other major urban centres including Cork, Galway and Limerick are suffering from severe traffic congestion. Also there are growing patterns of inter urban rail and bus travel. This has resulted in a number of initiatives such as major investment set out in the National Development Plan 2000-2006 of €2.8 billion investment in public transport. The general response to increase in demand has been to seek to increase the level and quality of services with new buses introduced in both Bus Éireann and Dublin Bus and quality bus corridors which have been created in Dublin. However, these improvements require not only capital funding but significant additional revenue funding to meet operational cost increases in an environment where fares have largely been held constant in nominal terms over a long period of time with only two single fare price increases in the past ten years.

3.2.2 In addition, there is major investment in the national and suburban rail systems, including new rolling stock for both the DART and the other Dublin commuter railway routes, which require increasing exchequer funding for capital and operating purposes.

Development of Government policy 3.2.3 The National Development Plan sets out public transport investment strategy for the

period 2000 to 2006 and a number of consultative documents have been produced addressing the development of policy, institutional, administrative and regulatory reform. These include:

22/08/02 Page 33

(a) A New Institutional and Regulatory Framework for Public Transport, published by DoT in August 2000 (the “Red Book"). This provided a basis for consultation with interested parties, particularly through the Public Transport Partnership Forum and a policy framework to guide the work of DoT in preparing the necessary legislative and other measures to give effect to the proposed reforms.

(b) New Institutional Arrangements for Land Use and Transport in the Greater Dublin Area - a consultation paper published by DoT and Dept of Environment and Local Government, March 2001, (the “Blue Book"). This considers the institutional arrangements for land use and transport in the Greater Dublin Area.

(c) Iarnrod Éireann, The Way Forward, A Report to the Minister for Transport, July 2001 - (the “Yellow Book") a report of a Review Group to make recommendations regarding the improvement, in an accelerated manner, in the organisation and management of the company to deliver a higher quality of focused service and value for money for the taxpayer.

3.2.4 A report is expected concerning policy on the regulation of the bus market outside Dublin and draft legislation is being developed on the institutional arrangements for land use and transport in the Greater Dublin Area, based on the Blue Book proposals.

3.2.5 In addition the Public Transport Partnership Forum (“PTPF”) was established in 2000 under the Programme for Prosperity and Fairness, as a forum to ensure that the Social Partners are involved formally in the consultation process. The non governmental participants in the PTPF have issued a response to the Red Book in April 2002. It agrees with the overall objectives of public transport policy and agrees inter alia with the restructuring of CIE subject to certain caveats.

Regulatory framework 3.2.6 Section 15 of the Transport Act, 1950 and section 8(10) of the Transport (Re-

organisation of Coras Iompair Éireann) Act, 1986 set out the public service obligation on CIE to provide public transport service on behalf of the State (and provides the justification for State subvention payments to CIE for provision of those services). EU Regulation 1191/69 (amended 1893/91)] provides for the termination of all public service obligations payments where a “PSC” has not been established. However, the Regulation also states a number of service types that are exempt from this requirement. This exemption includes provision of the following services:

(a) Dublin Bus – urban/suburban and inter regional services;

(b) Irish Rail – urban/suburban services and inter city services; and

(c) Bus Éireann – urban/Suburban services (but not inter city services).

3.2.7 As a result there is no statutory regulatory requirement to enter into a PSC with the current CIE operating companies (for the services specified). Nonetheless DoT is committed to introduce financial and commercial transparency and a defined process to measure value for money. These pending developments are in line with international

22/08/02 Page 34

developments for a performance and measurement regime and in line with the national context of the public service being more outcome driven as part of the modernisation of the public service.

3.2.8 Article 6 of EU Directive 92/50/EC (the “Service Directive”) allows direct award of a PSC where the service provider operates on the basis of an exclusive right and is also a 'contracting authority' within the meaning of the Service Directive (both of these criteria have to be satisfied). There is currently no statutory basis for the introduction of PSCs.

Government objectives 3.2.9 The objectives of Government public transport policy, as defined in the Red Book, are:

(a) to ensure the provision of a well functioning, integrated public transport system which enhances competitiveness, sustains economic progress and contributes to social cohesion;

(b) to ensure the provision of a defined standard of public transport, at reasonable cost to the customer and the taxpayer; and

(c) to ensure timely and cost effective delivery of the accelerated investment in infrastructure and facilities necessary to ensure improved public transport provision.

Assumptions

3.2.10 In writing this report we can only work in anticipation of the likely policy framework within which the subsidiary companies may be operating. The assumptions we have made on this future framework:

(a) the creation of commercial independent semi-State operating companies; and

(b) achievement of the Government objectives defined in paragraph 3.2.9.

3.3 The model for restructuring

3.3.1 Within the assumptions described in the previous section, the Government is still considering (and consulting on) the optimum form of restructuring. Under any scenario the restructuring of CIE should be carried out in a way that promotes transparency, efficiency (both financial and operational) and represents value for money for the tax payer. From the description of the drivers of change, it is evident that the environment within which the operating companies are operating will continue to evolve and that restructuring is likely to require a number of stages to complete. These are likely to include the legal separation of the CIE Group entities and the introduction of competition to certain markets. Market liberalisation and the legal constraints of public ownership may also lead to consideration of alternative ownership models. Within the

22/08/02 Page 35

confines of policy for the future development of the industry, as discussed above, we can describe certain traits for the new industry structure that should allow the envisaged changes. Under the headings of legal, financial, managerial and operational, we set out below traits that the new industry will need to accommodate. This exercise cannot be exhaustive but will permit testing of the framework for restructuring.

Legal

3.3.2 Under proposals set out in the Red Book, Dublin Bus and Bus Éireann are to be established as separate independent companies (this independent semi-State company structure has been endorsed by the Public Transport Forum in respect of Dublin Bus). Ownership of at least one of the bus companies may pass to the private sector. Whilst the Red Book envisages the division of Irish Rail into two independent companies (railway infrastructure and operation of railway services) the Review Group in the Yellow Book is of the firm view that infrastructure should remain within Irish Rail and, again, this has been endorsed by the Public Transport Partnership Forum.

3.3.3 Whilst any such restructuring would in itself require new legislation, once formed the independent companies would continue to be governed (amongst other things) by the Companies Acts, 1963 to 2001. The individual companies would be also be governed by regulatory frameworks pertaining to their respective areas of operation as they evolve.

3.3.4 Accordingly, the restructuring would result in ownership of the three operating companies passing directly to DoT as shown in Figure 3.1 below. Such a structure would encompass the creation of a group services company owned by the operating companies (this issue is set out in greater detail later in this report).

Figure 3.1 : Potential future ownership structure

Government(Department of Public Enterprise “DPE”)

IarnrodEireann

“Irish Rail”

CIE parent Co. (inc CIE Tours)

Bus Atha Cliath

“Dublin Bus”Bus Eireann

Group Services Company*

Government(Department of Transport “DoT”)

IarnrodEireann

“Irish Rail”


Bus Atha Cliath



22/08/02 Page 36

Financial 3.3.5 The Red Book states that the individual CIE companies will need to be financially

restructured to enable them to operate as single entities rather than as members of a group of companies. It highlights that borrowings are currently undertaken on a Group basis, and that loans and assets will need to be allocated to the individual companies and the financial implications of doing so will be have to be assessed. These issues are dealt with in detail in subsequent sections of this report.

3.3.6 There are a number of issues at an industry “macro” level, which should be taken into account in restructuring since they will impact on the financial position of individual companies. Examples include the way in which the industry is funded and the impact that restructuring is likely to have on the cost to Government in supporting the services which the operating companies provide. The operating subvention amounted to €247m in 2001 an 87% increase on 1997 levels. Capital grants amounted to €187m in 2001 and group debt stood at €246m – a small decline on 1987 levels. These financial measures are to a large extent a function of service level expectations and fares policy. We have set out below a list of factors relating to the restructuring which have the potential to change the amount of subvention paid by Government:

- further increase in the level of capital investment; - increase/decrease in the level of overall debt funding of the group;

- raise/lower the level of “public service obligation”;

- increases in other costs (eg. removal of State guarantee for debt, replication of

central service functions in each operating company);

- requirement for the achievement of Return on Capital Employed at levels which may be benchmarked against commercial markets and other public transport operators;

- revaluation/full charging of asset base (eg. Property);

- the level of fares in relation to the cost of providing services; and

- maximisation of efficiency levels.

3.3.7 Accordingly, when considering debt, property allocation and the treatment of insurance claims in detail we are mindful of the potential impact on the cost to Government of public transport. The restructuring also considers the broader objectives such as the potential in the future to access additional capital and the potential to pass risk to the private sector.

3.3.8 Tensions and trade-offs between objectives will need to be considered in the restructuring such as the desirability of providing operators with certainty over future levels of public service obligation support (to facilitate longer term planning and investment) set against Government’s requirement to maintain flexibility over

22/08/02 Page 37

commitments to such outgoings. The model for restructuring must be one where financial measures can be used with adequate transparency to assess the affordability and value for money of services provided. This is likely to include proper definition of the operating asset base for each company, the setting of a benchmarked financial rate of return on capital employed and systems for assessing efficiency in the delivery of a defined level of public service contract.

3.3.9 To the extent that these issues are not addressed at the outset of restructuring, Government will not have longer term control over the level of subvention that it is required to pay and will not be able to assess the relative efficiency of service provision. It may also not be possible to develop the operating entities to a stage where other ownership models may be contemplated.

3.3.10 Models adopted in other European jurisdictions have tended to commercialise State owned businesses as a precursor to privatisation. Objectives have often been set through the usual round of business planning processes rather than formal contracts. The requirement to achieve commercial rates of return has been a necessary financial performance measure, for example, power generating companies which on privatisation were required to generate a regulated financial return on its asset base.

3.3.11 A financial objective which imposes a year on year breakeven target inhibits long term planning and is not appropriate to sustainable commercial enterprise. There should be a requirement to grow shareholders’ funds in line with growth in revenues and costs, providing necessary reserves to deal with normal commercial risks, and to provide capital for replacement and development of assets.

Managerial 3.3.12 The Review Group in the Yellow Book recommends that “Irish Rail be separated from

the CIE Group and established as a separate company with its own Board, which would report to the Shareholder directly. The Shareholder should set out specific objectives to be achieved by the company over a number of years. Performance indicators or targets would cover the whole spectrum such as the areas of availability requirement, reliability requirement, end-to-end running requirement and service quality management”.

3.3.13 The Yellow Book goes on to say, “We cannot emphasise strongly enough that the Shareholder should not become involved in the day to day operations of Irish Rail... The principle behind our recommendations here is one of subsidiary devolution and delegation and involves the acceptance by the Board and Management of responsibility and accountability for the achievements of specific tasks, and the consequent rewards or sanctions for success or failure”, where clear objectives are set by the board for management, and shareholders involvement is to be restricted to structured performance reviews. While these recommendations were made in respect of Irish Rail they are equally applicable to Bus Éireann and Dublin Bus.

3.3.14 Whilst we can envisage, therefore, that the operating companies would have management devolved with sufficient authority to run the respective operations, the question remains as to the actual degree of autonomy management are given while the entities remain in public ownership. The extent of autonomy from Government will be

22/08/02 Page 38

determined by the framework surrounding the entities. For example, under the proposals set out in the Red Book an independent public transport regulatory function is to be established. The Blue Book sets out the form but not the content for the regulator for the Greater Dublin Area. The expectation would be that management are devolved sufficient flexibility to meet with service and financial obligations. The board and management structures and functions will need to be enhanced to meet these requirements.

Operational 3.3.15 Competition in the bus market is envisaged in the Red Book, specifically with the

introduction of route tendering in Dublin. This will necessitate the agreement of service contracts with performance measurement systems and penalty regimes. It is also likely to raise the issue of common access to certain assets, such as bus stations etc. Accordingly, any model for restructuring will require to be carried out in such a manner so as not to prohibit or hinder such eventualities. The ownership of operational assets and the ability to manage those assets effectively will be paramount for management. The way in which operators interact with each other and other competing entities will become formal and require the negotiation of arms-length contracts. This in itself will require the necessary resource, skills and funding.

3.3.16 The non-core companies and assets that will also need to be considered are:

(a) Rosslare Harbour;

(b) Dubel Limited; and

(c) CIE Tours International Incorporated.

Conclusion 3.3.17 The model for restructuring seeks to define the required structure to create sustainable

commercial semi-State companies with independent boards and a strong commercial focus that will also be required to demonstrate value for money to the taxpayer. Establishing such entities so that they can operate commercially will require them to be benchmarked commercially. Such an “optimal” model (as represented in the figure below) should include, inter alia:

1. a board of directors with an appropriate balance of executive, non-executive and worker directors, responsible to the shareholder, which in future would be the Minister for Transport and not CIE parent company;

2. an independent management team with the depth of resources to address all of the

necessary business functions of an independent entity;

3. detailed definition by DoT of the services to be provided;

4. definition, initially by the operating companies, of the asset base required to provide those services;

22/08/02 Page 39

5. creation by DoT of an efficient funding structure;

6. independent fares policy which is linked to operating subvention;

7. the setting of financial targets by DoT with the support of agreed levels of

subvention; and

8. arms-length agreements to be negotiated with other operating companies in respect of use of property, group purchasing and other services.

3.3.18 Each of the above items is essential to the creation of stable and sustainable

commercial enterprises. Items 1 and 2 need to be addressed in phases 1 of restructuring and items 3 to 8 must be addressed in stages 2 and 3.

The structure may need to be developed in a phased approach, which should allow sufficient flexibility to accommodate the future development of the regulatory and legislative environment. This is discussed in more detail in Section 12 of this report.

Figure 3.2: Potential optimal restructuring model

Payment for Public Service Obligations

Regulator/ Transport Authority

OperatingCompaniesRevenue

Arms length agreements with other operating companies

Government

Public service requirement

(with financial incentives/penalties)

Defined assets based on

operational requirements

Financial return achieved based on

appropriate risk profile and asset base

Financial Return

Payment of interest on debt as appropriate

Payment for Public Service Obligations

Regulator/ Transport Authority

OperatingCompaniesRevenue

Arms length agreements

Government

Public service requirement

(with financial incentives/penalties)









Financial Return

Payment of interest on debt as appropriate

22/08/02 Page 40

4. Financial Support for Public Service Obligation Key Points The existing regime for capital and revenue grants involves an annual budgeting round. This constrains long term planning. Increased operational costs resulting from capital projects are not adequately considered in the determination of subvention levels. A review of this process indicates that the following items are required:

1. the development and implemention of a detailed service specification including

monitoring and incentivisation mechanisms; 2. the development of an independent fares policy so that the basis of increasing fares

annually provides some commercial freedom to operating companies and is independent of the Minister for Transport;

3. the introduction of an appropriate legislative and regulatory regime; and 4. the further development of a capital projects evaluation methodology, so that cost

benefit analysis takes full account of long term operating costs .

Commensurate with element 1 will be a commitment from Government to greater certainty concerning future levels of subvention and fares policy to permit longer term planning by the operating companies.

Whilst an optimal restructuring would address all of these items, at a minimum it should address items 1,2 and 4, the implementation of which will be in part dependent on addressing item 3. This would permit an initial drive towards assessment of value for money.

4.1 Introduction

4.1.1 Financial support to CIE currently falls into two categories, namely capital grants and operational (or revenue) payments. This section seeks to describe the process of financial support allocation, the issues that exist as a result of this process and potential options for further development of the process. A profile of capital and operational payments since 1997 is provided in Figure 4.1 overleaf.

22/08/02 Page 41

0

50

100

150

200

250

300

1997 1998 1999 2000 2001

Ope

ratin

g su

bven

tion

€m

-

50

100

150

200

250

300

Cap

ital G

rant

s €m

op subvention

capital grants

Figure 4.1: Capital and operational Subvention, 1997 – 2000

This table must be considered in the context of significant expansion of fleets and services from 1999 with minimal fare increases to cover losses arising on new services and predictable operating cost increases.

4.2 Capital Grants

Description 4.2.1 The primary requirements for capital subvention can be summarised as:

(a) Dublin Bus – capital grants for new buses and depot/infrastructure development;

(b) Bus Éireann – capital grants for new buses and depot/infrastructure development; and

(c) Irish Rail – capital grant for safety improvements, operational infrastructure upgrade, new rolling stock and new infrastructure.

4.2.2 Capital grants are provided by both the DOT (from Department of Finance) and the EU.

22/08/02 Page 42

Allocation process

4.2.3 Two distinct types of capital grant requirement can be defined: that which has resulted from the proposals outlined in the National Development Plan; and that which is proposed by the operators as part of investment requirements of the ongoing business needs. The process for determining both the National Development Plan and base service capital grant allocation to each of the CIE operating subsidiaries is summarised below.

Stages National Development Plan (“NDP”) Base service Capital expenditure Step 1 NDP lays out plan for future infrastructure and

service requirements. Capital Expenditure budget developed.

Step 2 Subsidiaries/DOT/CIE determine capital investment needed to meet requirements of NDP.

Budgets submitted to CIE for consolidation and negotiation.

Step 3 Plan developed for capital requirements to 2006 - BUT no guarantee or commitment from Department of Finance to meet the costs over this period.

CIE submits subvention requests to DOT/Department of Finance for negotiation.

Step 4 Individual capital projects planned and programme developed by subsidiaries, costed over project life.

Capital Grant projects are agreed by DOT/Department of Finance.

Step 5 Annual funding negotiations to determine capital grant for each subsidiary for the next year – A three year rolling capital plan is agreed but it may not be adequate for services requested. The Irish Rail safety programme is an exception to this.

Annual funding negotiations to determine capital grant for each subsidiary for the next year – BUT no commitment from Department of Finance to fund future (beyond one year) forecast project spend, even if project commenced.

Issues

4.2.4 A review of this process has highlighted the following main issues:

(a) the scope of the capital plans can exceed the level of Department of Finance grant funding committed;

(b) any such funding gap can impact on borrowing requirements of CIE;

(c) the additional operational costs that result from implementation of capital funded projects is not fully considered in the overall allocation of operating subvention from Government;

(d) timing issues on payment of capital grants has in the past led to uncertainty of cashflow requirements and borrowing facilities being stretched;

(e) while a three year rolling capital plan is agreed with priority on specific projects, funding levels are only provided and committed annually, making long term capital expenditure planning difficult;

22/08/02 Page 43

(f) project priorities are developed through strategic planning, however, the link between the methodology used to evaluate the economic and social impact of capital projects and evolution of the capital project programme needs further development;

(g) National Development Plan capital plans appears to have been developed in isolation of available funding for operational cost; and

(h) the process does not enable projects to be prioritised (for benefits, timing or value for money) across subsidiaries or within subsidiaries.

4.3 Operational subvention

Description 4.3.1 The primary requirements for operational subvention may be summarised as:

(a) Dublin Bus – to fund the shortfall of farebox revenues over operating costs driven by a 30% increase in peak seats available and predictable cost increases;

(b) Bus Éireann – to fund the shortfall of farebox revenues over operating costs and driven by increased commuter services, social services and predictable cost increases; and

(c) Irish Rail – to fund the shortfall of farebox revenues over operating costs; to part fund ongoing safety related infrastructure maintenance improvements.

4.3.2 In contrast to capital grants, the Department of Finance is the single source of operational financial support. The Department of Finance (through the DoT) provides revenue subvention to the group who allocate it to subsidiary companies on an annual basis. This is based on financial support forecasts produced by the subsidiaries adjusted to meet the overall public sector expenditure budget.

22/08/02 Page 44

Allocation process 4.3.3 The process for allocation of operational subvention to each of the CIE operating

subsidiaries is summarised below.

Stages Description Step 1 Operational budget developed for the base timetable service requirements (to include

additional budget developed for additional service specification resulting from capital expenditure related projects).

Step 2 Budgets submitted to CIE for consolidation and negotiation. Step 3 CIE financial support request to DOT/Department of Finance for negotiation. Step 4 Subvention level agreed by DOT/Department of Finance – any downward adjustments

are made and a block subvention is passed to CIE. CIE will then allocate this block to subsidiaries – based on budget totals but also adjusted to account for cash position from previous year.

Step 5 Revenue funding levels are agreed in principle with DOT in advance, but payment is received in instalments over the financial year – final payment level from DOT is often agreed late in the financial year.

Issues

4.3.4 A review of this process has highlighted the following issues, which significantly

impact medium term financial planning which in turn impacts post restructuring funding structures.

A formal public sector performance and measurement regime does not currently exist within CIE or between CIE and DoT

Current implications Minimal clarity as to requirement of services from the operating companies; No clear planning/obligation of detailed service requirements, or formal measure for DOT on level of service provided – under development; Uncertainty for DOT on “what you get for your money”; No forward planning ability for operators to link capex and service levels; Inability to forecast revenue/cost for an extended period; No measure of cross-subsidy of profitable routes to unprofitable routes; Subvention requirements do not necessarily reflect a realistic revenue surplus. Fare increases are not subject to independent regulatory structure Current implications No ability to accurately forecast revenue into the medium/long term; Fares cannot be adjusted to reflect service level improvements (be it scope, quality or frequency) or the direct operating cost increases attributable to these improvements; Fares are not adjusted to reflect other operational cost increases (e.g. wages, fuel, maintenance). Regulatory and legislative proposals Current implications Charge in legislation will be required to allow subvention be paid directly to operating companies; Lack of transparency on cross–subsidy of services may have EU procurement implications; Service cross subsidy not considered in block subvention.

22/08/02 Page 45

4.4 Conclusion

4.4.1 As a result of the current assessment a number of broad areas that should be developed as part of the restructuring of CIE to improve the overall capital and operational financial support process have been identified:

(a) While key performance indicators are being developed there is a need to develop them further, and implement a more detailed service specification including monitoring and incentivisation mechanisms along the lines developed for the operation of Luas to:

• provide transparency between costs of financial support and service performance and quality (legislative requirement);

• increase the ability to plan services and business & financial management; • provide historical data to enable benchmarking to assess comparative

performance; and • provide the ability to manage capital investment and service delivery cost.

(b) Develop an independent fares policy which:

• enables fares to reflect service quality and performance, and operational cost (including wages) of service delivery;

• allows some commercial freedom to operating companies; • is independent of the Minister for Transport.

(c) Introduce an appropriate legislative and regulatory regime to:

• place formal service specific obligations on operators; • ensure a structured, long term (e.g. 5 yrs) subvention obligation from

government; and • enable development of a structure to facilitate overall strategic transport

planning.

(d) Further develop a capital projects evaluation methodology to:

• incorporate a comprehensive assessment of economic/social benefits; and • include operational cost of capital projects in evaluation process.

These issues must be addressed in stage 2 to establish sustainable commercial enterprises.

22/08/02 Page 46

4.4.2 The items identified in this section will assist in addressing many of the financial support issues presented in relation to the current financial support process. Nonetheless, the levels of financial support and the process to determine these levels will also be impacted on by a number of other key external drivers to restructuring such as those identified in Section 3 of this report, namely increased passenger demand, Government policy, and the changing regulatory environment.

4.4.3 As discussed in Section 3, the treatment of many other business drivers such as property, claims and debt and the capital structures that result from any restructuring will also have a significant impact upon financial support requirements. The issues associated with these areas are discussed in more detail in the following three sections.

22/08/02 Page 47

5 Property

Key Points

• The CIE property portfolio is currently held by the CIE parent company which does not charge the operating subsidiaries for use of freehold property. Lease costs are charged on to the operating companies. The depreciated historic cost of this portfolio amounts to €139m at 31 December, 2000.

• Under any scenario for restructuring the operating companies will require the continued use of operational property. As independent management entities, they should be provided with flexibility and incentives to use property in the most efficient manner. The usage, ownership and financing of property should be viewed as separate matters.

• There are broadly two options concerning the redeployment of the CIE property portfolio: - Option 1: transfer the ownership of the operational property from the CIE

parent company to where it is required in each operating company. This may include transfer to an independent entity for property requiring common access, such as bus stops/stations, where ownership may better reside with an independent authority. Any necessary transfers to an independent authority need not happen initially but could happen as and when the regulatory model evolves. We understand that this is the preferred option of operating company management and consistent with recommendations made in the Yellow Book in respect of Iarnrod Éireann’s property.

- Option 2: continue to hold the property in a central property holding entity which would offer potential to retain central management, ownership and control. Access to operational property would then be permitted using arms-length lease contracts, incorporating economic rents.

• Either of these options can provide a pragmatic solution for property. There are a number of important issues that are required to be resolved before a final decision on property ownership in each operating company is arrived at. These include: - the nature of the development of a competitive market; - a legal review of EU regulation; - the nature of regulation for the Irish market place; - a legal review of property titles.

• Under either option certain constraints should be placed on the use of property to assure preservation of the asset base for public transport use. Clawback arrangements should be put in place to capture any subsequent realisation of surplus value.

• Whilst constraints might be placed on primary use of property, consideration should be given to incentivising operators to develop the environment for their customers, including development of peripheral services, such as retail franchises and commercial development. Introduction of an agreed measure for return on capital would provide a driver for further commercial development and exploitation of property assets.

• Charges should be implemented for use of property by an entity which is not the owner and principal occupier.

22/08/02 Page 48

5.1 Introduction

5.1.1 A restructuring of CIE raises some key issues concerning the portfolio of property largely because it represents a potentially valuable asset which whilst key to the provision of services may have a higher value for alternative use. Accordingly, the issues raised in connection with the property portfolio fall into two areas. The first relates to the future legal ownership of property which is currently vested in CIE parent company. The second relates to the provision of property services, both from CIE parent company that has a property department comprising a team of 22 staff, and Irish Rail which provides property maintenance services to itself and other group entities. This latter service item is dealt with in Section 10.

5.2 Description

Property portfolio

5.2.1 The property in the CIE portfolio comprises a range of operational and administration buildings ranging from depots, garages, bus and railway stations to city centre office space. Some of the sites have multiple access by various of the CIE companies, such as Heuston Station in Dublin, which is used by both Irish Rail and Dublin Bus and Broadstone, which is used by both Dublin Bus and Bus Éireann.

Title

5.2.2 The portfolio comprises both freehold and leasehold buildings and title to them was passed under a number of Acts relating to the establishment of CIE. There are no formal leases or sub-leases in place between CIE parent company and the operating companies.

Capital value of portfolio

5.2.3 Property is held in CIE parent company at cost and is depreciated over 50 years based on historic cost. As at 31 December 2000 the net book value of property was shown in the CIE parent company balance sheet as €139m. The original cost of most property is fully written off and this balance represents the depreciated cost of additions since 1986. The current market value of the property will be a multiple of the book value. Whilst a report by DTZ, (December 1999) has reviewed the scope in the property portfolio for disposal of property surplus to operational requirements, there is no current market valuation for the property on the basis of existing operating company usage.

Charging

5.2.4 The operating companies are not charged for full economic use of the freehold property which they occupy/use. Rent for specific leased sites and rates are passed on to relevant operating companies by CIE parent company property department. However, maintenance is paid for by the operating companies.

22/08/02 Page 49

Surplus Property 5.2.5 CIE has in the past pursued a policy of disposing of surplus property and a number of

sites have been sold achieving revenues for CIE. More recently its strategy has been to maintain an economic interest in divested property in order to benefit over the longer term from its subsequent development. This is a controversial area given the latent value in the portfolio and the perception that releasing some of that value may be used to raise funding for CIE. In contrast there exists a belief at an operating level that this may have a future detrimental impact on the long term strategic needs of public transport.

5.2.6 The Yellow Book makes specific reference to the requirement for a long term perspective concerning usage of property, citing inadequacies with the old policy of disposing of surplus assets for short term financial reasons where a subsequent operating need emerged.

5.2.7 In the restructuring of the London bus market operating properties were vested in the operating companies. Surplus properties were retained for sale or redevelopment within London Transport’s general property portfolio. Clawback mechanisms were put in place to ensure that any onward sale of the properties did not allow stripping of profits. Certain property requiring common usage (e.g. bus stations) remained in the ownership of London Transport.

5.3 Issues

5.3.1 The CIE property portfolio has accumulated and been inherited over a long period for the operational benefit of the CIE operating companies. A restructuring of the CIE companies forces a number of key generic issues to be addressed. These relate to operational requirements, valuation and charging, and commercial exploitation. There are in addition a number of specific issues pertinent to each of the operating companies. There is uncertainty surrounding the eventual competitive and regulatory environment within which the bus companies will be operating. Short-term redeployment of the CIE property to permit the restructuring of CIE should be carried out in a way that does not preclude refinements which may subsequently be required, for example, access to depots on the introduction of route franchising to the Dublin bus market.

Operational requirements 5.3.2 The requirement for use and ownership of property assets by the operating companies

should be determined by the operational requirements of those entities. This can only be addressed within the context of a model where management have devolved responsibility and commercial flexibility for delivering services against fully specified service obligations. The legal position regarding the ability to move properties to the operating entities will need detailed planning, as the title to many of the properties is founded in statutory provisions which have evolved since the nineteenth century.

22/08/02 Page 50

Valuation and charging 5.3.3 The CIE property portfolio raises issues on restructuring largely because of its latent

market value and in particular with regard to the potential for alternative usage. The full value of the property is only of relevance where it is to be divested or where a charging regime is to be implemented for its usage. (It may also be an issue were it to be used to bolster the net asset value of an operating company to provide security to support debt funding). As has been adopted in other European restructurings, consideration must be given to the implementation of restrictions concerning property usage and clawback arrangements on any disposal. This might be considered as less of an issue where the operating companies remain in State ownership. However, it still raises the question of where the surplus cash benefit of any disposal would fall.

5.3.4 Under the existing structure the operating companies are not charged for the usage of freehold property. This should be reviewed since a charging regime would bring the following benefits:

(a) greater transparency of costs;

(b) promotion of efficiency;

(c) compliance with EU requirements concerning subsidisation of transport services; and

(d) the move to a commercial basis for the operation of the companies.

5.3.5 Economic charging for use of those assets will impact on management’s strategy for property. The cost effects of charging should be netted off against additional subsidy and, accordingly, should result in no additional cost to Government. However, in reality there are likely to be additional transaction and tax costs associated with charging for property usage. Therefore, consideration should be given to an initial stage of restructuring, with no or limited charging, followed by a movement to full market charging over time where required.

5.3.6 The operating companies do not require immediate direct ownership of the property to gain operational benefit, and indeed may benefit from greater operational flexibility by not directly owning all property. For example, where a management team wishes to achieve lower property costs by moving administration offices, then providing notice to terminate a lease may prove easier than seeking to divest of a property.

22/08/02 Page 51

Commercial exploitation 5.3.7 A distinction should be drawn between the development of CIE property to the

exclusion of the provision of services required under any service obligation (for example, commercial development for alternative usage) and the desirability of permitting operators to develop peripheral commercial activities which enhance the environment for passengers/employees and offer potential to generate additional income for operators such as retail franchising or advertising. Owners of property should be mandated to optimise the return on property assets consistent with high quality transport services delivery.

Bus Depots and Garages

5.3.8 Any regulatory model based on competition will need to address the issue of access to operational property. In other jurisdictions where competition has been introduced, depots have either been sold along with certain routes (for example, The London model) or access has been provided using a charging regime for depots which remain in public ownership.

5.3.9 Generally access to depots is exclusive as operators tend to require full control over the maintenance of their buses and coaches and the location of depots is usually critical to the route network serviced. Generally in Europe, where new market entrants have entered existing markets, these new entrants have been required to source depot facilities independently. An important issue, particularly in areas of urban conurbation, is the geographic location of depots relative to the route network which is being served as this can greatly influence the efficiency of the operator.

5.3.10 There will be a balance for Government on restructuring between the desire to preserve the depot network and permitting sufficient flexibility to the operators to control their own businesses.

5.3.11 Environmental surveys may or may not exist for depots but careful consideration should be given to the acceptance by Government of the liability for any contamination which might have taken place prior to restructuring. This is only likely to become an issue should the property be passed to the private sector as protections are likely to be sought in this regard by any private sector investor.

22/08/02 Page 52

Bus Stations and Street Furniture

5.3.12 Multiple access to bus stations/street furniture etc. will be an issue for any competitive market. Other jurisdictions have predominantly followed a model whereby such property is held by a local transport authority. This clearly has strong attractions since that entity can be seen to be impartial amongst operators and consideration should be given to such a model, particularly in Dublin, where the transport authority would be the obvious owner. Outside of Dublin, ownership could reside with any eventual transport authority.

Bus station developments have been funded out of group cash flows. Any transfers of operating property out of the Group should be made at current valuations.

Irish Rail

5.3.13 The Yellow Book comments that a large part of CIE’s property assets are attached to the rail transport business and that those assets which are necessary for the strategic development of the rail company should be vested in it. These comments might be seen to apply equally to Dublin Bus and Bus Éireann. The issues relating to value and charging as set out above apply equally to the rail property as do the comments concerning clawback arrangements. Irish Rail currently complies with EU legislation concerning the separation of operations and infrastructure. Whilst the Yellow Book recommends no separation of operations and infrastructure into separate legal entities, the restructuring of the property portfolio should be achieved in such a manner so not to prohibit any further restructuring as may be desired in the future.

22/08/02 Page 53

5.4 Options

5.4.1 In consideration of the above issues there are broadly two options concerning the restructuring of the property portfolio

Option 1 Transfer the ownership of the operational property from CIE parent company to the operating company for which it is required. Pros Cons

Achieves a clean restructuring with no residual property holding company.

A restructured industry which leaves only the three operating companies is likely to prove to be more efficient, avoiding additional administrative costs.

Offers potential for a “transitional” period

pending regulatory developments. Particularly in the case of Dublin Bus, where

development of the regulatory framework may require further modification of the approach to property, "parking" of the assets in Dublin Bus would not prohibit such changes.

Potential for commercial flexibility For example

a sale and lease back of property. Ownership is vested with those who have

greatest interest in maintaining (and developing) the sites. Operating entities more closely resemble independent commercial entities.

Enhances the Balance Sheet of the operating

companies and may provide some security for debt.

Clear definition of property assets to meet operational objectives.

• Entrapped value/clawback mechanismsWere properties to be sold then any financial gain would reside in that operating company. Mechanisms have been used in other jurisdictions (notably in the London bus market) whereby any such profit is clawed back from the operating company. (These arrangements could perversely entrap value for Government).

• Ability of operating companies to establish future requirements

• Whilst criticism has been levied at previous disposals of "surplus" property, given the uncertainty surrounding the likely future operating environments, operating companies may find it difficult to predict any additional future property requirements (in addition to that currently used).

• Operating companies need specialist resources to move into property and retail development.

• Constraints should be imposed on primary usage but this would not prohibit peripheral commercial development.

• A number of models exist which permit multiple access to sites. This may require certain properties to be held by appropriate central entities.

• Funding of property presents challenges for

return on capital employed.

The transfer of property into the operating companies will require funding to maintain solvency of the holding company. Initially this may be at written down book value which would minimise the value of the initial transfer. Over time it may be appropriate to revalue the property assets. The initial transfer of property may be achieved in a non-cash or cash transaction:

• Non-cash increase in shareholders funds in the operating subsidiary (and thereby the equity investment to be acquired by government); or

22/08/02 Page 54

• a cash based transaction using borrowings in the operating subsidiary (returning cash to holding company on transfer of property).

The decision as to which route to follow will be determined by the strategy for debt funding.

Option 2 Hold the property in a central property holding entity. (An entity owned by DoT, strategic land use and transportation authority, Irish Rail , or combination of these). Operating companies would then enter into arms-length arrangements for operational use of property. Pros Cons Potential to realise value for Government

It would be possible to explore the feasibility of securitising the income stream relating to all or part of the property portfolio or sale and lease back. The trade-off would be between an initial cash receipt against higher ongoing subsidy.

Ability to maintain economies of scale

By avoiding disaggregation of the portfolio the economies of scale achieved from central management of the portfolio would be preserved.

Greater flexibility provided to operating

companies. Property could be provided to operating companies on relatively short term leases which would leave management with greater flexibility over commitments to property usage.

Capacity to accommodate property

management function. Since the property portfolio would be maintained

in one place, this would provide the obvious location for the management team.

Maintains control over entrapped value

Were any property to be divested, and the cash receipts would automatically fall within the property holding company and not with one of the operating companies.

Operating company management remains

focused on operational agenda.

Fails to achieve a clean restructuring (residual property holding company).

The presence of further entities is likely to result in greater costs, administration and governance issues.

Requirement to establish a charging regime.

The move to economic charging is likely to be required early in the process of restructuring.

Burden of putting contracts in place. The

establishment of arms-length contracts is a complex, costly and time-consuming process.

Ownership and development is removed from

operational requirements.

5.4.2 Whichever option is chosen, consideration will need to be given to the accounting and

taxation implications which will include stamp duty, value added tax and capital gains taxes.

If it is decided to retain property in a central property holding entity then the existing legal entity of CIE parent company could be used This would allow for a change of name of this entity. In these circumstances no transaction costs would arise from reorganising the property portfolio. Value added tax implications would arise on entering into formal lease arrangements with the operating companies.

22/08/02 Page 55

In the absence of any specific new statutory provisions, capital gains tax and stamp duty would arise on the transfer of property from CIE parent company and the subsequent transfer of ownership of the operating companies outside the CIE group.

An appropriate value at which such property is incorporated in the accounts of the operating companies will also require to be determined.

If tax costs arise, provision for funding of these costs will also require to be made. Taxation issues should be neutral for the exchequer and should not, therefore, be a driver of decisions in this area.

5.5 Conclusion

5.5.1 There are several issues that need to be determined before a firm decision in relation to the acquisition of property by the operating companies can be finalised. These include:

(a) Commitment from government to reduce overall amount of Group debt. The Group cannot retire debt from operating cash flows and therefore the resolution of property ownership is linked to decisions on retiral of Group debt.

(b) Five year forecast cash flow plans of operating entities, which include realistic assumptions on fares, subventions, capital grants and service levels. This is required to assess operating companies ability to support third party debt without government guarantees.

(c) Scope of proposed regulatory environment for the bus markets and the way in which controlled competition will be expanded in both the greater Dublin area and outside Dublin.

(d) Administrative burden, cost and governance arrangements to maintain a semi state entity to own, operate and/or exploit some of the existing property portfolio of CIE Group Holding Company.

(e) The complexity of the title to key operational properties and issues to be resolved to effect a transfer of ownership.

(f) Resolution of objectives and issues associated with a property charging regime and EU law.

5.5.2 The initial steps in developing the appropriate property ownership and funding arrangements for each of the operating entities include:

(a) development of a property register by operating entity covering;

• description of asset and principal uses;

22/08/02 Page 56

• current book value and depreciated replacement cost;

• inter company usage and licensing proposals;

• current title and issues to be resolved to effect transfer;

(b) assessment of operating companies’ requirements for immediate and future operating plans; and

(c) allocation of appropriate weightings to the benefits and disbenefits set out in options 1 and 2 on pages 53 and 54.

5.5.3 Any one of these options could provide a pragmatic solution to property ownership. There are several important issues set out above that are required to be resolved before final decisions on property ownership in each operating company can be reached.

5.5.4 Whilst management should be given commercial flexibility to run the affairs of the business, in recognition of the valuable/unique nature of the property assets of CIE it is recommended that, as has been implemented in other jurisdictions, constraints be placed on the primary use of property and clawback arrangements be put in place to agree and share in the proceeds of any disposal or refinancing. This should not preclude management from imaginative solutions to property requirements nor for example a refinancing of property through a sale and lease back or outsourcing arrangement.

5.5.5 As the competitive market is developed the proposed regulator for the Dublin area and areas outside Dublin will need to decide on appropriate arrangements for access to Bus Éireann bus stations. Should the regulator decide that such stations be owned and operated by a public or regulatory authority then these assets should be acquired at value by the relevant authority at that time.

5.5.6 In the event that Dublin Bus’s market is at some future point open to route franchising and this entails the requirement to provide dedicated depot(s) associated with certain routes, then dedicated access could be permitted by way of lease at defined rates. Alternatively, the Dublin regulator could acquire the relevant depots at fair value and charge any competitor a common lease rate.

22/08/02 Page 57

6 Claims

Key Points The CIE Group currently self-insures for all third party and employers’ liability risk other than catastrophe. Unfunded claims reserves amount to €157m at 31 December 2001. The issues that arise on restructuring are:

• substantial initial funding implications of transferring to a third party insurance

arrangement and related impact on annual cost; • legal viability of continuing with self-insurance arrangements in the context of

private investment; and • the continuation of effective in-house management of the function.

The options on restructuring are:

• Option 1: continue with self insurance; • Option 2: establish a direct writing captive insurance company; or • Option 3: seek third party underwriting.

To enable restructuring to commence the pragmatic solution is to continue as is with Option 1. This would result in little change to the capital requirements of the CIE Group. The operating companies would continue to avail of the cashflow benefits but equally would be exposed to the risks of under-reserving. The potential would exist to move to either Option 2 or 3 over time if necessary, but with very substantial funding requirements.

6.1 Introduction

This section comments on the specific implications for claims reserving and funding and claims management.

The CIE Group currently self-insures for all third party and employers’ liability risk other than catastrophe. As at 31 December 2001 the following reserves are reflected on the balance sheets of each of the group and the individual CIE Group companies:

22/08/02 Page 58

Year ended 31st December 2001 CIE

GroupIarnrod Éireann

Bus Atha Cliath

Bus Éireann

€'000 €'000 €'000 €'000Balance Sheet: Third party and employers liability claims (< 1 Year): 19,908 3,901 11,563 4,444 Third party and employers liability claims (> 1 Year): Balance at 1st January 2001 146,752 53,183 63,240 30,329Utilised during the year -16,013 -4,807 -6,275 -4,931Transfer from profit and loss account 26,493 6,999 12,408 7,086Balance carried forward 157,232 55,375 69,373 32,484Less: Transfer to current liabilities -19,908 -3,901 -11,563 -4,444Balance at 31st December 2001 137,324 51,474 57,810 28,040Total Balance Sheet Liabilities: 157,232 55,375 69,373 32,484

6.2 Issues

6.2.1 The main issues to be addressed, in respect of claims, on restructuring are:

(a) initial funding implications of transferring to a third party insured arrangement and related impact on annual cost;

(b) legal viability of continuing with self-insurance arrangements in the event of private sector investment; and

(c) the continuation of in-house management of the claims function and the retention of the critical mass and related efficiencies available from existing group arrangements.

6.3 Options

6.3.1 Going forward the main options available to address structuring and funding the run-off of existing estimated claims liabilities are as follows:

(a) Option 1: To continue with self insurance;

(b) Option 2: To establish a direct writing captive insurance company, via a portfolio transfer of the existing claims liability book; and

(c) Option 3: To seek third party underwriting, via a portfolio transfer of the existing claims liability book.

22/08/02 Page 59

6.3.2 The implications of each option are examined below.

Option 1: Self insurance 6.3.3 Continuing to self-insure remains a practical option for each of the operating

companies, as long as they remain in State ownership. This would result in little change to the balance sheet position of the operating companies. The companies would continue to avail of the cash flow benefits currently enjoyed by self-insurance (for the year 2000 and 2001, self-insurance generated €10m of current cash flows in each year). The companies would equally continue to be exposed to the risks of under-reserving.

6.3.4 The operating companies will be exposed to the cash flow implications of any acceleration in claims settlement or any reduction in the size of bus companies that may result from a franchising process (as outlined in the Red Book). In the event of size reduction the operating companies will have to fund the run off in claims without the annual charge from ongoing activity.

6.3.5 The bus companies are exempt from independent insurance requirements under the Road Traffic Act, 1961. This exempt status will require careful review in the event of any transfer of shareholding to the private sector.

Option 2: Establish a direct writing captive insurance company 6.3.6 The establishment of a captive insurance company would serve to remove the claims

liabilities reserves off each of the individual operating companies’ balance sheets. At portfolio transfer date a premium would be payable to the captive by each of the operating companies proportionate to their share of total claims liabilities at transfer date (31 December 2001 €157m). In addition to a premium payment, additional investment in such a captive company would be required to meet solvency requirements in the first instance and economic capital requirements in the second.

6.3.7 Based on publicly available information as at 31 December 2001, 200% of the solvency margin requirement could be estimated to be of the order of €16m, (using the “second result” solvency margin requirement calculation as prescribed by the DETE for non-life insurance companies). However, the commercial capitalisation requirement for such a captive insurance company may be higher, depending on the actual weighting of underlying risks (the solvency margin calculation assumes equal weighting of underlying risks). An actuarial assessment should be carried out to determine transfer values and capital requirements in the event that this option is pursued.

6.3.8 Ownership of the captive insurance company would likely be structured to reflect the proportionate transfer of claims liabilities, supplemented by proportionate additional capital investment, from each of the operating companies. In order to reflect the proportionate ownership structure, the board of directors of such a company would likely include members from each owner/customer company.

22/08/02 Page 60

6.3.9 Establishment of a captive insurance company, to which a claims portfolio transfer would be effected, would create a future capital strain for the operating companies as they would have to pay over an annual premium. The companies would no longer benefit from the delay between charging for claims and subsequent settlement many years later.

6.3.10 The funding benefits currently enjoyed from existing self-insurance arrangements would be lost to the operating companies in this scenario. Liability reserves carried on the balance sheets of the operating companies represent zero interest medium term finance, that is very significant in relation to the total balance sheets of the CIE Group companies. The claims reserve at 31 December 2001 stands at € 157m. and have grown from € 116m. at 31 December 1997.

Option 3: Third party underwriting 6.3.11 Similar to the captive option, to outsource underwriting of the CIE Group claims book

would serve to remove the claims liability reserves off each of the individual CIE Group companies’ balance sheets. At portfolio transfer date, a premium would be payable to the external insurance company by each of the CIE companies proportionate to their share of claims liabilities at transfer date. Unlike the captive option, there would be no further capital requirement in respect of historic claims provisions, other than the annual premium charged by the third party insurer. However, a profit margin would be built into any premium charged by an external insurance company. The only way to accurately estimate the range of insurance premium likely to be charged by a third party insurance company would be to engage an insurance broker to carry out an exploratory exercise.

6.3.12 Similar to the captive option, the funding benefits currently enjoyed from existing self insurance arrangements would be lost in the event of transferring the existing claims book to a third party insurance company and additional financing would be required by the operating companies on an annual basis.

6.3.13 Should this option be considered, very careful assessment of the claims management arrangements must be carried out. The medium term implications of changed arrangements could result in increased profit margins being built into future premium levels and a disimprovement in the claims management performance and related future premium costs.

Options Summary 6.3.14 Claims investigations and management services are currently provided by head office

to each of the CIE Group companies. A separate department exists within CIE Group, consisting of approximately 22 personnel which deals with thousands of incidents on an annual basis.

22/08/02 Page 61

6.3.15 Under Option 1 the continued provision of investigation and claims management services to the CIE Group companies could be retained “in-house” and could be facilitated through the establishment of a shared services company. Similar to the captive scenario, ownership of such a company could be representative of the “customers” of that company.

6.3.16 Under Option 2 above, it would be appropriate to include claims investigation and management services as part of the package to be provided by the captive insurance company to each of its owners/customers. The fee to be charged to each owner/customer to cover the cost of investigation and management services provided could be included as part of premium charges or could be separately identified. Under this option existing liabilities plus an adequate solvency margin would have to be funded. Annual premiums would have to be paid accelerating claims cash outflow.

6.3.17 Under Option 3, it could be possible that investigation and claims management would be outsourced to a third party insurer as part of the transfer of underwriting risk. It is feasible that under this scenario the current claims cost focus could be diluted. Existing liabilities (2001: € 157m.) would have to be funded and annual premiums (including a profit margin) paid over significantly accelerating claims cash outflows.

6.3.18 Key to any claims management function with a focus on future claims cost control is close liaison with risk management functions. Facilitating such close liaison should be a requirement of the future claims investigations and management services provider. This could be aided by the inclusion of risk management personnel on shared committees with the investigations and claims management provider.

6.3.19 The issue of “ring-fencing” existing claims liabilities, and the provision of funding for such liabilities, would arise under each option in the event that change of ownership of either of the bus companies or the rail company are considered in the future.

6.3.20 It can be expected that any latent claims or unreserved risks would remain with the existing shareholder on any change of ownership.

6.4 Conclusion

The operating companies should continue to self insure while in State ownership. Alternative structures at option 2 or 3 could be put in place if alternative ownership arrangements are considered with the substantial funding requirements explicit in such options.

22/08/02 Page 62

7 Debt

Key Points • CIE group had net debt of €246m at 31 December 2001.

• CIE parent company is holder of all group debt and provider of treasury

management functions. The group borrowings are guaranteed by the State which permits optimal costs of borrowing. The existing debt funding structure is of a historic nature.

• The primary objectives of financial restructuring are two fold being:

- to refinance the Group at sustainable debt levels in the context of its future cash flows and its financing requirements for development and renewals;

- to establish the operating companies with funding structures that achieve the optimal capital structure.

• The issues concerning borrowings on restructuring are:

- there has been no substantial reduction in debt levels since the restructuring in 1987;

- any re-allocation of the existing debt to the operating companies on restructuring will maintain the same level of global borrowings and, assuming continuation of the State guarantee, result in broadly the same global interest charge;

- in advance of full understanding of the eventual operating environments it is not possible to determine appropriate levels of gearing for the individual operating companies;

- the ability to service debt will be determined by future cash flows which will be a function of fares, subvention, service requirements and costs within the evolving regulatory framework;

- the restructuring will lead to an increased cash funding requirement for the CIE Group of Companies;

- recent losses have further pressurised the debt structure.

• Prima facie there is no benefit from attempting to re-allocate the existing borrowings. The desirability of having some borrowings allocated to the operating companies in the early phases of restructuring is more closely related to the focus it would provide for management and DOT for operating companies to manage and generate cash.

• Accordingly consideration should be given to a capital injection to retire a

significant portion of the debt.

• The debt retirement should be initially focused on Irish Rail where the debt levels have been constant with no reduction in debt levels since the 1987 restructuring. This debt amounts to € 171m at 31 December 2001. We recommend full retirement of this debt given there are no current prospects of repaying the debt through operating cash flows.

22/08/02 Page 63

• The bus companies are currently debt free. Consideration should be given to allocating a portion of the debt to the bus companies in conjunction with any transfer of property into these companies. This would effectively force the bus companies to show an economic return on the property transferred into the companies in as much as they would be required to fund the debt. These financing costs would effectively have to be settled either by increased revenues, likely to be fare increases, or through increased operating subvention. This would provide an efficient capital structure and a more transparent financial model but would not necessarily affect group operating performance. The quantum of debt transfer will depend on the 5 year financial forecasts which should be prepared. It will also be essential that the companies be allowed capacity to borrow further amounts to fund ongoing capital expenditure requirements.

• The residue of debt is at the CIE parent company level. This should be reduced

by (i) the settlement of the LUAS debtor of €47m; this is a timing issue; (ii) the transfer of debt to the bus companies; and (iii) the State retiring the balance.

7.1 Description

7.1.1 The CIE Group carries a significant debt component in its financing structure. A summary of the gearing at the year ends 31 December 1997 to 2001 is set out in the following table. The table examines gearing both as direct debt and also with debt and third party and employers insurance claims aggregated. This second test is performed as the build up of claims provisions at CIE effectively allows CIE access to a significant additional interest-free source of temporary funding.

2001 €’000

2000€’000

1999€’000

1998 €’000

1997€’000

Equity (note *) 195,740 203,577 181,708 141,874 111,227 Debt 245,693 194,679 199,035 188,127 187,166 Total debt and reserves 441,433 398,256 380,743 330,001 298,393 Gearing ratio debt as a % of equity

1.26%

96%

110%

133%

168%

Third party and employers insurance claims

157,232 146,751 137,368 128,062 116,011

Debt and Third party and employers insurance claims 462,925 341,430 336,403 316,189 303,177 Debt and Third party and employers insurance claims as a % of reserves

205% 168% 185% 223% 273% Note * the table above classifies the non repayable State advances as equity.

22/08/02 Page 64

7.1.2 Net debt at 31 December 2001 rose significantly from previous years due to investment in the LUAS project. At 31 December 2001 the CIE Group had invested €47m in LUAS which will be refunded to the CIE Group in 2002. While the group has the capacity to service these debt levels it has not been able to generate sufficient cash flow to retire any significant portion of the debt, and as a consequence debt is a hard core feature of the group financing structure.

7.1.3 A detailed analysis of CIE Group debt at 31 December for the years 1997 to 2001 together with a repayment profile is summarised in the tables below.

2001 €’000

2000€’000

1999€’000

1998 €’000

1997€’000

Due within 1 year 178,052 115,950 106,080 82,995 67,294 Due between 1 and 2 years

7,426

6,646

9,837

7,259

23,588 Due between 2 and 5 years

25,730

33,084

33,499

35,639

36,326 Due after more than 5 years

34,485

38,999

49,619

62,234

59,958 Total 245,693 194,679 199,035 188,127 187,166 7.1.4 The net debt is made up of bank overdrafts, a variety of different bank loan structures

and finance leases, in addition to which the group had undrawn facilities of €57.3m at 31 December 2001.

7.1.5 The above table discloses the position at 31 December each year, and as CIE generally receives a final payment of its annual subvention in December each year, the debt levels indicated can be considerably below the peak borrowing requirements of the Group, that reached €328m in 2001.

Analysis of debt by operating company 7.1.6 Under current legislation CIE parent company undertakes all financing arrangements

including overdrafts, loans and finance leases on behalf of the CIE Group and advances the required funds to the operating subsidiaries through intergroup advances. The current legislation restricts the State guaranteed borrowings to a maximum of €317m, augmented by a short term facility of €51m. Bus Éireann and Irish Rail also have certain direct operating lease commitments.

7.1.7 Whilst debt is legally held by CIE parent company, an analysis of net debt across the group has been undertaken. The table below shows the debt position in 1987 (the year after the creation of CIE in its current form), 2000 and 2001.

31 December 2001€000

Net debt/(cash)


Net debt/(cash)


Net debt/(cash) CIE holding company 113,056 83,597 48,250 Iarnrod Éireann 170,617 121,352 196,809 Bus Éireann (2,266) (4,823) 21,586 Bus Atha Cliath (35,714) (5,447) 11,428 Total Debt 245,693 194,679 278,073

22/08/02 Page 65

7.1.8 This debt profile shows a consistent debt requirement for CIE parent company and Irish Rail, whilst Dublin Bus and Bus Éireann have shown year end cash surpluses in 2000 and 2001. The substantial rise in debt in CIE parent company can be largely attributed to a €47m short term investment in the LUAS project which is due to be repaid in 2002.

Cost of debt

7.1.9 The level of long term debt funding has resulted in annual net interest costs to the CIE Group as shown in the Table below.

2001€millions

2000 1999 1998 1997

Net interest cost 11,143 11,143 12,468 14,384 15,373 % of total operating costs 1.4% 1.6% 2% 3% 3% 7.1.10 Interest is calculated on the debt/cash balances at the end of each month for each

operating company with an appropriate interest charge or credit made to each of the operating company and CIE parent company. The interest cost in the CIE parent company is then recovered from the subsidiary companies.

7.2 Issues

Optimum gearing structure 7.2.1 The existing debt structure of CIE Group is not the result of a structured funding policy

based on key funding ratios and an objective of optimum gearing. It has persisted because the level of operating income and subvention has been insufficient to enable any repayment of debt – a consistent position since 1987. As a consequence of this, CIE has had to rely on extensive grant support to fund the recent capital investment programme.

7.2.2 Any re-allocation of the existing debt to the operating companies on restructuring of CIE parent company will maintain the same level of global borrowings. Assuming continuation of the State guarantee and subject to the netting off effect achieved by CIE Group treasury management, described below, this will result in the same global interest charge.

7.2.3 In advance of a full understanding of the eventual operating environment, the ability to determine efficient levels of debt to be carried by each operating company is severely constrained, as the ability to service debt will be determined by future cash flows which, in turn, will be a function of fares, subvention, service levels and costs.

7.2.4 Prima facie there is no benefit from attempting to reallocate the existing borrowings, as interest charges are supported by subvention. The desirability of having some borrowings allocated to the operating companies from the early stages of restructuring is more closely related to the focus it would provide for management and DoT for operating companies to generate surplus cash to service borrowing. Cost of capital is a real cost for the business.

22/08/02 Page 66

7.2.5 The following issues would need to be assessed prior to deciding on the debt capacity of the operating companies:

a) Third party and employer’s liability claims. There has been a substantial build up in the levels of third party and employer’s liability provisions due to the retrospective claims payment process. Any acceleration of the claims process may have a significant impact on the cash flow profile and consequently the debt requirement of the operating companies.

b) Property charges. At present no charge is made to the operating companies for property. Should a decision be taken to leave the property in a separate property company then each operating company using the property will need to pay rentals for the cost of the property including the funding of an appropriate replacement reserve. These decisions will have a substantial impact on the cash flow of each operating company.

c) Subvention. Key decisions on whether the subvention process should include a strategy for debt retirement as well as debt servicing will have to be taken. As present the subvention together with the trading cash flows have in general not been sufficient to reduce the debt burden of the group.

Treasury management

7.2.6 The current treasury structure allows cash and debt to be managed on a CIE Group wide basis, and as a result cash generated in any individual operating company can be used to reduce the overall debt requirement of the CIE Group on a daily basis. At 31 December 2001 Dublin Bus and Bus Éireann had a combined theoretical positive cash balance of €38m. Had this not been netted off, the group debt requirement of the CIE parent company and Irish Rail would have increased by €38m.

State guarantee 7.2.7 Currently all CIE debt is State guaranteed, and this guarantee brings the benefits of

lower financing costs. The ability of the operating companies to negotiate facilities without the backing of a State guarantee in the future will be determined primarily by future cash flows and secondarily by the asset base against which such debt could be secured.

7.2.8 The asset base of the operating companies might be derived from non-property assets such as rolling stock and buses (where not leased) or from property vested to the operating company balance sheet. It should be noted that current legislation requires the approval of both the CIE and operating company boards prior to disposal of property assets. This restricts the use of certain property assets, which would reduce the ability of operators to use the assets as security for debt.

22/08/02 Page 67

7.2.9 Future cash flows will be generated through farebox revenue and subvention payments from Government. However, given that subvention accounts for approximately 45% of total revenue, it is likely that the uncertainty of the current annual subvention process will not provide lending institutions with the required certainty to satisfy themselves that the operating companies have sufficient capacity to meet repayment terms. Given the financial constraints of the CIE companies under the current subvention regime it is probable that no facilities will be granted to the operating companies without the backing of a State guarantee. Accordingly any new financing arrangements or reassignment of existing facilities at existing levels will require a continuation of the State guarantee, or a change to be made to the subvention regime. Changes in the market regulatory arrangements may have implications for the renewal of the State guarantee as this may be viewed as State aid under EU rules.

State advances 7.2.10 CIE parent company currently has state advances of €12.511m. These advances are

disclosed separately in the CIE Group balance sheet reserves. The terms and conditions attaching to these advances will need to be formalised prior to final restructuring of the CIE Group balance sheet.

Other issues 7.2.11 The current legislation will need to be revised to allow the operating companies enter

into debt arrangements on their own behalf and not through CIE parent company as directed in the current legislation.

7.2.12 Any transfer of finance leases to operating companies should be made based on existing usage of rolling stock and bus assets. This would have required the transfer of €2.9m of finance leases to Dublin Bus at 31 December 2001.

7.2.13 Given that peak borrowing requirements have historically been in excess of year end borrowing, the operating companies will require either cash balances or working capital facilities to finance such movements. As with commercial entities dedicated working capital facilities should be put in place in addition to any long term debt funding.

7.2.14 Limitations should be placed on the operating companies borrowing capacity. This will vary dependent on the option chosen for the allocation of existing debt. Should any of the operating companies commence with no long term debt funding, then it may be considered desirable that appropriate constraints both at board and shareholder level would be put in place concerning the raising of debt to develop the business. These constraints should relate to the primary objectives and scope of the business.

22/08/02 Page 68

7.2.15 On restructuring of CIE Group the debt funding facilities will require to be refinanced, repaying the existing facilities held by CIE parent company and putting in place appropriate new facilities for each of the operating companies. The costs and process involved in terminating the existing debt facilities, any penalties for early termination, unwinding any hedging etc. will represent a key issue in managing this process. Where possible the existing facilities should be assigned to the operating companies rather than new facilities entered into. Specific advice should be obtained on each facility to effectively manage and negotiate the reassignment and or refinancing of these facilities in the most cost effective manner.

7.3 Options

Objectives of financial restructuring 7.3.1 The primary objectives of financial restructuring are three-fold:

• review the existing levels of debt and assess whether these are appropriate to the current business/restructured business;

• as the shareholders objective is to make the operating companies sustainable

commercial enterprises, then there is a clear need, in the context of existing operating regimes, to reduce substantially current levels of group debt; and

• to establish the operating companies with funding structures that achieve the lowest

weighted average cost of capital.

Options description 7.3.2 There are four options concerning the CIE Group debt as follows:

Option 1 : Retire some/all of the debt This option will be driven principally by Government’s desire or ability to fund a repayment or agree to have the existing debt reassigned as State debt. Approximate levels of sustainable long-term debt funding need to be established for each of the operating companies.

It may be possible to restructure CIE in such a manner that cash could be generated to repay some of the existing debt: for example, the sale of shares in the operating companies to the Minister for cash, the disposal of peripheral assets or refinancing of owned assets, such as a sale and lease back of freehold property merit further detailed consideration.

22/08/02 Page 69

Option 2 : allocate the majority of the debt to Irish Rail and some debt to Dublin Bus and Bus Éireann supported by cash flow (assured future subvention) and assets (property) Whilst it may not be possible to determine an efficient capital structure for either Dublin Bus or Bus Éireann during the early stages of restructuring because of the evolving operating environment and consequent inability to predict future cash flows with any degree of certainty, it may nonetheless be considered desirable to allocate an amount of existing debt for the following reasons:

• provide a home for some of the existing debt; • simulate the eventual capital structure; • provide an objective for management and DoT for the companies to generate

surplus cash to service debt and provide a more efficient capital structure; and • enable those businesses to develop treasury management skills.

The balance of remaining debt would be allocated to Irish Rail. Over time as a greater understanding of the operating environment becomes clearer, it would be possible to move the capital structure of Dublin Bus and Bus Éireann to more efficient levels.

Option 3 : Allocate the existing debt to Irish Rail Given the inability to determine appropriate levels of gearing for Dublin Bus and Bus Éireann during the early stages of restructuring and that Irish Rail currently pays the interest pertaining to the existing debt, existing debt could be allocated to Irish Rail.

This would leave Dublin Bus and Bus Éireann free of long term debt during the early stages of restructuring. As outlined at 7.2.4 above, this may be considered undesirable.

It may be possible to maintain the State guarantee and consequent preferential rate of funding for a longer period under this option.

Option 4 : Allocate part of the existing debt to a new property holding entity

In Section 5 we discussed the option of allocating property to a new property holding company. If this option is selected, decisions on appropriate charging for use of such property will be required.

This new property holding entity could sustain debt commensurate with its net income stream. Furthermore, this entity could consider alternative means to fund property holdings, such as sale and leaseback arrangements.

22/08/02 Page 70

7.4 Conclusion 7.4.1 Consideration needs to be given to retiring a significant portion of the debt as it is

unsustainable. This can be done by either re-assigning the existing debt to the State or injecting funds into CIE to facilitate the repayment of the debt.

7.4.2 The debt retirement should be initially focused on Irish Rail where the debt levels have

been constant with no real reduction in debt levels since the 1987 restructuring. We recommend full retirement of this debt, which stands at €170m at 31 December 2001, given there are no current prospects of repayment of the debt through operating cash flow.

7.4.3 The bus companies are currently debt free. Consideration should be given to allocating a portion of the debt to the bus companies in conjunction with the transfer of any property into these companies. This would effectively force the bus companies to show an economic return on the property transferred into the companies in as much as they would be required to fund the debt. These financing costs would effectively have to be settled either by increased revenues, likely to be fare increases, or through increased operating subvention. This would provide a more efficient capital structure and a transparent financial model but would not necessarily affect group operating performance. The quantum of debt transfer will depend on the 5 year financial forecasts which should be prepared. It will also be essential that the companies be allowed capacity to borrow further amounts to fund ongoing capital expenditure requirements.

7.4.4 The residue of debt is at the CIE holding company level. This should be reduced by (i)

the settlement of the LUAS debtor of €47m. This is a timing issue. (ii) the transfer of debt to the bus companies (iii) the State retiring the balance.

22/08/02 Page 71

8 Pensions

Key Points

• CIE has two final salary pension schemes, both of which are well funded • On restructuring, there are broadly two options:

- Option 1: creation and administration of separate pension schemes; - Option 2: continued shared participation in the existing schemes.

• Whilst the operating entities remain in public ownership, the advantages of

option 2 “continued shared participation” are likely to result in this option being the preferred route initially. These advantages relate to minimisation of changes for employees, savings in administration costs and the avoidance of splitting up the funds.

8.1 Description

8.1.1 At present the CIE Group of Companies operates two final salary (defined benefit) pension schemes:

CIE Pension Scheme for Regular Wages Staff; and CIE Superannuation Scheme 1951, (Amendment) Scheme 2000.

8.1.2 The latter scheme was formed by the amalgamation of the previous four clerical schemes at which time certain benefit improvements were implemented.

8.1.3 Both schemes have benefit designs based largely on the public sector model, and in line with these public sector norms, pension payments are increased at a rate broadly equivalent to general pay increases in the public sector. In these schemes, however, this is not guaranteed to be the case, although adherence to this practice over time will have created the expectation for it to continue into the future.

8.1.4 Benefits are calculated on final salary at retirement at the rate of one-eightieth for each year of service. In addition a tax-free cash gratuity is paid equal to three times the annual amount of pension payable at retirement age. Also in line with the public service, there are fairly generous early and ill-health retirement terms.

8.1.5 Contribution levels from members are 3% approximately for Scheme A and between 5.125% and 9.625% for Scheme B. There is a governing limit of 2.7 times members’ contributions for the employer contribution level in Scheme A, after which there is capacity to share cost. There is no limit to the employer contribution level in Scheme B.

22/08/02 Page 72

8.1.6 Both schemes were well-funded in the last actuarial reports produced as at 31 December 1999. Recent informal reports prepared for management post 11 September 2001 indicate an adequate level of funding albeit at a reduced level.

8.2 Options

Scheme structure

8.2.1 On restructuring, the three operating companies would have the option of:

(a) creating and administering their own scheme; or

(b) continuing to participate with each other as at present.

8.2.2 It is assumed that no changes in scheme design/participation rules take place. That subject is covered later.

Advantages Disadsvantages Separate Schemes

• Costs and performance clearly identifiable

• Separate identity established • Easier to effect any change

• More expensive to run – separate documentation, actuarial work, administration costs

• Costs involved in segregating assets • Possible contentious issues – surplus

allocation, etc. Shared Participation

• Reduces possible contentious issue • Savings in administrative and other

costs • No splitting of assets

• Need to formalise contract for administration services

• More difficult to effect changes • Need to notionally split assets to arrive at

separate contribution rates and funding levels

8.2.3 In order to achieve the option of allowing the three operating companies to participate

in a single scheme the following has to be accomplished:

(a) documentation to permit the three operating companies to participate in one scheme;

(b) notional split of assets and surplus; (c) separately identified funding rates for each company; and (d) establish contract for administration services.

8.2.4 Whilst these are comparatively straightforward tasks, they should be audited by an

external source in order to re-assure all parties of the equitable distribution of assets and reasonableness of the now separate contribution rates.

22/08/02 Page 73

8.2.5 Formalisation of the administration services provided by a central services company by means of a contract between that company, the employer and the scheme will be required. These and other services, such as investment management and actuarial, can have their costs shared in an agreed manner.

8.2.6 The application of FRS 17 “Accounting for pensions” requires the disclosure in the 2001 and 2002 financial statements and the accounting for on the balances sheets of the individual companies in the 2003 financial statements of the pensions schemes assets and accrued liabilities. This will require an allocation of pension schemes assets and liabilities by operating company. This can be achieved by calculating the overall asset to accrued liability ratio for the scheme in total terms. The accrued liabilities should be calculated by operating company. The asset to accrued liability ratio can then be applied to the accrued liabilities calculated by operating company to derive the assets to be applied to each operating company.

8.2.7 Before the final results are made public, the following steps should be undertaken to ensure good stewardship:

(a) review investment performance; and

(b) assess efficiency of administration process.

Scheme Design/Participation rules 8.2.8 Once the three operating companies have been restructured, each would also have to

consider whether the present public sector design and terms would be appropriate going forward either immediately or at some future date. Any change in arrangements for existing employees would have to be by agreement.

8.3 Conclusion

Whilst the three organisations remain in public ownership, there are advantages in maintaining shared participation. If the schemes do not change their fundamental nature of final-salary public sector design, there are no apparent advantages to splitting the scheme. Furthermore, by not splitting the fund, it will remove potential employee concerns, which will be especially important in the context of the partnership approach to resolution of industrial relations issues.

22/08/02 Page 74

9 Other Financial Issues 9.1 CIE shareholding in operating companies

9.1.1 The CIE parent company holds financial investments of €90m, based on 1987 values, representing CIE parent company’s 100% shareholding in the three subsidiary companies: Irish Rail, Dublin Bus and Bus Éireann. The shareholders’ funds in each operating subsidiary at 31 December 2001 is as follows:

€ Millions

Irish Rail 86

Bus Éireann 33

Dublin Bus 28

Total 1987 values plus subsequent retained profits 147

On the proposed restructuring of CIE, these shareholdings are likely to be transferred to the Minister for Transport to allow direct ownership in these companies.

9.1.2 CIE was established by the Transport Act, 1950, as a board, which is a body corporate with perpetual succession and an official seal. However, it does not have a shareholding and there are no provisions relating to dividends or distributions, contained in the Transport Act, 1950. The Transport (Reorganisation of Córas Iompair Éireann) Act, 1986 which provides for the establishment of three subsidiary companies (Dublin Bus, Bus Éireann and Irish Rail) also provides that neither the board nor any member shall transfer or alienate any share in the company concerned. Section 7 of the Transport (Reorganisation of Córas Iompair Éireann) Act, 1986 provides for the Board to hold one share and to appoint a nominee to hold the second share, where two members are required and it is only the transfer of nominee share which is permitted under the Transport (Reorganisation of Córas Iompair Éireann) Act, 1986. Therefore, any transfer of shares from the Board to the Minister will require an amendment to the Transport (Reorganisation of Córas Iompair Éireann) Act, 1986.

9.1.3 Prior to transfer of shares, decisions will be required in relation to the appropriate transfers of operating properties to operating companies and the funding of any such transactions. In the first instance, this could be carried out at the net book amounts of relevant properties as included in the CIE parent company accounts.

9.1.4 The funding of such property transfers to the operating companies could be done on (a) an inter-company account with the CIE parent company, (b) third party debt raised by the operating company, or (c) the issue of new equity by the operating company to the CIE parent company.

22/08/02 Page 75

9.1.5 Transferring shares in the operating companies to the Minister could be effected, following necessary legislative change, by a cash settlement at net book value or by a distribution. The book value of the shareholdings will be significantly affected by decisions in relation to property transfers and the way in which such transfers are financed. If property is transferred in return for equity then the book values of the operating companies will increase by a comparable amount.

9.1.6 Transfer of shares to the Minister for Transport for cash consideration would allow the CIE parent company to retire a corresponding amount of debt.

9.1.7 Should the transfer happen by way of a distribution then a prior careful financial and legal assessment of the distributable reserves of the CIE parent company will be required.

9.1.8 The rights of and security held by creditors in the CIE parent company will also require careful prior evaluation and appropriate arrangements made to enable liabilities to be discharged as they fall due.

9.2 Taxation

9.2.1 The taxation aspects of the proposed restructuring will require detailed review and consideration. The aim will be to ensure that the restructuring is implemented in a manner that minimises tax costs. Generally speaking, the transfer of assets can give rise to significant liabilities to capital gains tax and stamp duty. Transfers between CIE owned entities can probably be undertaken on a tax free basis but significant tax costs can arise where ownership of the transferor or transferee companies subsequently changes.

9.2.2 Transfers of land/property, for example, train and bus stations will be of particular concern because in many instances the sites will have development potential and may therefore have a market value which is significantly in excess of their current use value to CIE.

9.2.3 Other tax considerations will include:

(a) the preservation of accumulated tax losses for the period post restructuring and post any ownership change;

(b) minimising any VAT costs arising on the restructuring; (c) the need to minimise tax liabilities accruing at the passive corporate rate of 25% as

against the active income rate of 12½%; (d) maximising tax deduction available for interest costs; (e) tax efficient planning of the restructured group insurance arrangements; and (f) managing tax aspects of any employee transfers from holding company that may

arise - These will largely be procedural items such as tax clearances to ensure continuous service is preserved.

22/08/02 Page 76

10 Central Services Key Points A number of functions are undertaken within the CIE parent company that are

required either to support the day to day services of the operating companies or are required for consolidation and reporting of group performance to DoT. The restructuring of the CIE Group should ensure that the boards and management of each of the operators have sufficient functional resource and systems support to enable them to continue to manage the businesses efficiently and effectively as independent entities.

To facilitate this, a change management process will need to be instigated and

managed by a dedicated change team that contain representatives from a broad range of stakeholders of the CIE Group including senior management (both from the operators and the parent company), worker representatives and the DoT. The team will also need specialist input for key areas such as change management, human resources and communications. This team will:

• identify the operational and management requirements of the operators; • develop a resource allocation process for all functions; • analyse the cost impact of restructuring; • develop a transition plan for the restructuring process; and • facilitate and promote the change process.

The issues that need to be addressed in relation to each of the services provided by the CIE Group have been identified and, where appropriate, options have been identified for the treatment of these services resulting from the restructuring process. Allocation of the CIE group services (be it to an operator or another body) resulting from restructuring has been assessed, and the possible placement of them at different stages of any restructuring process is presented in Section 12.

10.1 Introduction 10.1.1 A number of functions are undertaken within CIE parent company that are required

either to support the day-to-day services of the operating companies or are required for consolidation and reporting of group performance to DoT. These services (which account for less than 3% of the current CIE Group cost base) and the current number of employees in each are indicated below (the “CIE Group Services”):

22/08/02 Page 77

Employees Cost (2001 budget forecast €m)

Group IT and Telecoms 69 4,003 Claims Management 22 1,231 Solicitors department 22 1,610 Property Services 22 2,700 Group finance and Treasury (inc Salaries and Pensions)

21 702

Internal Audit 11 581 Group HR and personnel 6 305 Group Secretary 5 571 Group Marketing, Media and PR 6 284 Programmes and Projects 4 310 Chairmans Office 2 1,391 Total 190 13,688

10.1.2 This section will:

(a) assess the generic implications of restructuring on CIE Group Services; and (b) review each of the CIE Group Services central functions and provide options on the

approach required to enable the continued provision of these services following restructuring.

10.1.3 CIE management has also considered the implications of restructuring of the CIE

Group, and provided DoT with a report on their findings. This report has also been taken into consideration by PricewaterhouseCoopers in completing this review.

10.2 Generic restructuring issues

10.2.1 Whilst it is necessary to assess each of the services provided by CIE parent company, there are a number of generic restructuring issues associated with the services as a whole that need to be considered within the context of the overall change management process, including the maintenance of the operational and management requirements of the operators, the resource requirements of the future structure and the cost implications of the restructuring process itself. Throughout the process one of the key objectives will be to balance these three factors against the overall objectives for restructuring with effective change management as indicated in Figure 10.1 below.

Figure 10.1: The balance of the change management process

Cost

Operations & managementResource

ChangeProcess

Cost


ChangeProcess

Cost


ChangeProcess

22/08/02 Page 78

10.3 Change management

10.3.1 During any period of transition within a business there is a fundamental requirement to develop and plan for the change process. The process will need to be actively led and managed by a team that contains representatives from a broad range of stakeholders of the CIE group of companies including senior management (both from the [operators and the CIE parent company]), worker representatives and the DoT. The team will also need specialist input for key areas such as change management, human resources and communications. An outline of the stages that could be anticipated through the restructuring process, and the implications for the process, if each stage is not completed successfully, is set out in the table below.

Stage Actions Unsuccessful outcome Pre-planning Identify:

• Change sponsors • Change targets • Change agents Define broad change strategy.

Lack of clarity and senior management buy-in.

Contact Inform people that change is coming and approximate timescales.

Those directly affected are unaware of the process from an early stage, reducing potential for long term buy-in.

Awareness of change Communicate the outline restructuring plan and key milestones. There is unlikely to be much detail on how, what, who, where or when at this stage.

Confusion of all stakeholders on the key objectives.

Understanding the change

Explain the details of the restructuring. Indicate potential impact on functions (or individuals) .

Negative perception of what the change will mean to individuals/stakeholders.

Positive perception Establish support systems (eg training) to: • Build confidence in the process; • Establish active change agents

across the companies.

Decision by stakeholders not to attempt or support the implementation of restructuring.

Implementation Begin the actual restructuring process Establish monitoring process to enable early identification of problems.

Adoption New structures begin to become accepted. Longer term restructuring issues begin to be addressed. Ongoing monitoring of restructuring.

Restructuring aborted after initial stages.

Institutionalisation New structures and operating environment become accepted as the “norm”. The systems, management and operating structures established to support the new structures.

Internalisation Restructuring has positive, committed support from all stakeholders.

Restructuring is aborted after more extensive time period.

22/08/02 Page 79

10.4 Operational and management requirements

10.4.1 The context of the assessment of the CIE Group Services is to ensure that, post restructuring, the boards and management of each of the CIE operating companies have sufficient functional resource and systems support to enable them to continue to manage the business efficiently and effectively in a commercial environment.

10.4.2 There are a number of principles that will need to be considered to ensure that the functional requirements of the CIE operating companies are met in any restructuring:

(a) maintain the existing skills within the CIE Group and ensure these are reallocated in a manner to support the activities of the operating companies;

(b) maintain operational efficiency and effectiveness both through the transition phase and beyond; and

(c) develop more commercially based support service provision.

10.4.3 In addition to these operational requirements, it will also be essential that the boards and management teams of the CIE operating companies have adequate depth of skills and experience to manage the expanded and more commercially driven businesses. Whilst the board structures of the current operating companies have undergone considerable change in recent years and have been strengthened with the appointment of a number of independent non-executive directors, it should be noted that the service contracts for incumbent managing directors of Bus Eireann and Dublin Bus will expire by 2003.

10.4.4 As a consequence of restructuring, the management teams will be directly responsible for all aspects of the business and will therefore be required to manage a wider range of legal and financial responsibilities. As a result, a key requirement of the change process will be to review the existing management structures and resources, identify gaps and any appropriate steps required to ensure that they are sufficiently robust for the new business environment.

10.5 Resource allocation

10.5.1 In attempting to deliver the functional needs of the operating businesses, there are a number of ways in which the resources required could be sourced appropriately. These options are not mutually exclusive and it would be expected that some functions may require a combination of at least two of the following (set out below) to ensure the requirements identified in paragraph 10.4 can be met:

(a) Devolve existing CIE resources to the operators. All the CIE Group Services functions that support the day-to-day operations of Dublin Bus, Bus Éireann and Irish Rail are currently serviced by CIE employees. Whilst the scope and emphasis of these functions in a restructured organisation will need to be assessed, the majority of the technical requirements will remain. In this respect there is an imperative to ensure that continuity of functional experience and knowledge is

22/08/02 Page 80

maintained where appropriate. There will clearly be a demand for resources to provide service in the operating companies. This will also reduce the cost of the restructuring in terms of disruption and also any costs that would be incurred from recruiting new staff.

(b) Utilise existing operator resources. Existing resources in the CIE operating companies provide many associated services currently provided by CIE. Optimal utilisation of the existing resource base through the expansion of existing roles would provide a number of clear benefits to the operators. These benefits would include; enabling existing employees to develop their skill base and potentially enhance their career development; ensuring the continuity of existing employees’ operating environment experience; and the use of existing resource could help minimise any increase in cost provision for any given function where existing CIE resource is insufficient to meet the needs of all operating companies.

(c) Outsource functions. For certain services it may be appropriate for operators to consider outsourcing the CIE Group Services. There are a number of potential benefits to outsourcing, including; the ability to develop a more commercial basis for service provision and enabling market rates to be tested and exploited, reducing overall cost and increasing service level transparency to the operator; enabling critical mass advantages of current shared services to be maintained for at least the medium term (e.g. in IT provision, or claims management).

(d) External recruitment. The need for external recruitment is likely to vary both between functions and between operators. It is also likely to result from either an identified skills gap within the existing resource pool, or through the need to increase the actual resources available to the three operators. The key benefit, in addition to bridging an identified skills gap, is the introduction of new commercial experience and knowledge to operators.

10.5.2 Each of these approaches would need to be addressed in a structured and planned manner and the resultant plan would form an integral part of the change programme. The trade unions should also be involved from an early stage in the process.

10.6 Cost of restructuring

10.6.1 The cost incurred as a result of restructuring is the final element of the change process equation that will need to be balanced with the resource and functional aspects.

10.6.2 In estimating the cost impact of restructuring, three elements will need to be assessed:

(a) Existing cost base. The existing cost base incorporates personnel, systems, financial and establishment charges for both CIE parent company and CIE operating companies. The magnitude of the cost impact of restructuring will be dependent on the costs of additional resources that will be required to ensure that the operating companies continue to function effectively. The current level of cost for group services will increase, as many of the group services are replicated in each of CIE operating companies;

22/08/02 Page 81

(b) Scale efficiency costs. CIE currently achieves procurement scale efficiencies, whereby the critical mass of the group results in cost savings. eg. in oil supplies. In addition, CIE provides a number of services to the operators, such as IT, that are likely to achieve some scale advantages. These purchasing efficiencies can be retained through co-operative group buying practices; and

(c) Change process costs. The process of change itself will require investment, both in terms of financial input to employ change consultant specialists but also in terms of DoT and CIE resources that will need to be dedicated to restructuring.

10.7 Generic functional plans

10.7.1 A detailed assessment and implementation plan for each functional area of CIE Group Services will need to be completed as an initial output of the preparatory change management process as a matter of urgency. Whilst their development is outside the scope of this study, the plans will need to incorporate the following generic assessment:

(a) a detailed assessment of the existing central services functions, and a functional needs assessment of the operating companies as independent entities;

(b) a skills assessment (gap analysis) to determine the overall resource requirements of the restructured companies;

(c) identification of specific operational and management issues that will need to be developed to enable restructuring to be successfully implemented;

(d) identification of the HR/IR issues that will need to be dealt with throughout the process of restructuring; and

(e) analysis of the cost impact of restructuring of CIE.

10.8 Group IT and Telecoms

Overview 10.8.1 IT services for the CIE group are provided by Group Information Technology and

Telecommunications (“Group IT&T”). Group IT&T has 69 staff and provides an extensive range of IT services, including:

(a) application development and support; (b) infrastructure services;

(c) help desk and user support; and

(d) IT management services.

10.8.2 There are no IT departments within the operating companies themselves. There is, however, a business systems management (“BSM”) function within each of the

22/08/02 Page 82

operating companies that is responsible for ensuring that the IT needs of the businesses are fully met.

Systems 10.8.3 The systems in use across the CIE Group can be broadly categorised as follows:

(a) SAP. SAP is the principal financial and logistics systems for CIE and each of the operating companies - there are approximately 1,100 users of SAP across the CIE Group;

(b) VAX. There are a substantial number of older legacy systems running on VAX platforms - the majority of these systems were developed in-house in COBOL by Group IT&T;

(c) Client-Server Packages. Where possible, newer systems being deployed are packaged applications. These are specific to each of the companies and the majority run on an NT/Oracle platform; and

(d) Web Applications. The operating companies have a significant web presence, each with their own individual systems.

The majority of the systems are housed by Group IT&T in their Oriel Street premises. Role of Business Systems Manager 10.8.4 Each of the operating companies has a Business Systems Manager (in some companies

supported by a small support team) who is responsible for:

(a) the strategic development of IT within the business; (b) maximising the benefits of IT for the business; and

(c) managing the delivery of IT within the business.

10.8.5 The BSM focuses on:

(a) defining requirements for business systems; (b) sourcing systems solutions, taking account of the Group IT strategy and the skills

within Group IT&T;

(c) project managing new implementations, involving Group IT&T in particular for all technical and infrastructure elements;

(d) agreeing support requirements and levels with Group IT&T and managing the

delivery of IT service from Group IT&T with the Head of IT; and

22/08/02 Page 83

(e) working with Group IT&T to establish and manage support contracts with external

suppliers for specific package applications. 10.8.6 There are minimal IT technical skills within the CIE operating companies and they are

dependent on Group IT&T for such skills. The CIE operating companies are also reliant on Group IT&T for general IT management functions in relation to policies and controls.

Role of Group IT&T 10.8.7 Group IT&T provides the primary IT services that each of the operating companies

would expect from their own individual IT departments. Their role is to plan, design, implement, operate and support systems that meet the business needs of the companies in a cost effective manner. The key IT services provided by Group IT&T to the operating companies are:

(a) configuration, maintenance and support (business and technical) of the SAP system; (b) application development and implementation support;

(c) legacy systems (VAX) support and maintenance;

(d) infrastructure (hardware, operating systems, databases and network) planning,

implementation and support;

(e) end user support, including Helpdesk; and

(f) management of CIE Group-wide maintenance and support contracts with external suppliers.

10.8.8 In addition, Group IT&T is responsible for general IT management activities such as:

(a) business continuity and contingency planning;

(b) capacity planning and performance monitoring; and

(c) security policy and monitoring. 10.8.9 Group IT&T is also responsible for managing telecommunications across the Group,

including the PABX and contracts for both the land lines and mobile phones.

IT Cost allocation 10.8.10 The relationship between Group IT&T and the operating companies is not operated

on a fully commercial basis. A budgetary process is followed and IT budgets are agreed for the CIE operating companies based around projected support/maintenance requirements and resource requirements for new implementation projects. However, the CIE operating companies do not control the IT budget as ultimately the total costs of Group IT&T are apportioned across the operating companies.

22/08/02 Page 84

10.8.11 While agreed resource usage is allocated directly to a particular operating company at an agreed rate, all other costs are apportioned. There is little incentive for any of the CIE operating companies to manage Group IT&T costs closely for any particular activity since any overrun arising after direct charges will eventually be charged back to the operating company as an indirect apportionment.

Restructuring actions 10.8.12 Ultimately the individual operating companies must determine how their IT needs are

best served and the type of IT organisation which can best deliver these needs. The main organisational options are set out in an organisational assessment conducted by Eircom for Group IT & T (October 2001).

10.8.13 There is a critical mass of IT skills within Group IT&T upon which the CIE operating companies are dependent. In addition there is a common technical infrastructure that promotes synergies across the companies and provides economies of scale (e.g. SAP implementation). The skills and expertise within Group IT&T should not be broken up in the short term. However, the relationship between Group IT&T and the individual companies should be adjusted to give any of the companies the ability to move forward independently, and in a managed way, should they so wish in the future.

10.8.14 Each of the companies, together with Group IT&T, should prepare for restructuring and a number of actions can be taken in this regard:

(a) Implement formal Service Level Agreements (“SLA”). Detailed SLAs should be implemented between Group IT&T and each of the operating companies. The SLAs should define all aspects of IT service delivery including:

• respective responsibilities;

• performance metrics and how performance will be measured;

• costing mechanisms; and

• sanctions for under-performance.

(b) Move relationship to a financial/commercial footing. In tandem with the

introduction of formal SLAs, the relationship between Group IT&T and the companies should move to a more commercial basis. Group IT&T should be run as a profit centre, agreeing charges with the operating companies in advance for the services they require. This would allow:

• the CIE operating companies to fully manage all their IT costs; • group IT&T to accurately plan future resource requirements; and

• the CIE operating companies to benchmark Group IT&T service delivery

against other offerings in the marketplace.

22/08/02 Page 85

(c) Continue to reduce reliance on VAX based systems. A significant number of business critical systems still operate on VAX platforms. The majority of these applications were developed in-house with COBOL some time ago. The specialised skills required to support these systems could effectively result in the operating companies having an enforced longer-term reliance on Group IT&T. In recent years many of the VAX based systems have been replaced and indeed projects are underway in the individual companies to replace many of the remaining systems. This process should be continued with all business critical applications being moved away from VAX technology as soon as practical. Such a move will allow:

• group IT&T to focus resource development on modern, readily marketable

skills; and • the operating companies to be less reliant on ageing technology, very specific

skill sets and individuals.

(d) Operating companies to formulate a strategic view for future IT delivery. As part of the restructuring preparation, each of the operating companies should consider their strategic future direction towards IT delivery. Such consideration should include:

• the role of an IT function within the operating company and the skills that

would need to be acquired to fulfil the vision of such a role; and • the mechanism for delivery of IT services in the future. This potentially could

be in-house, using external service provider(s) (including a restructured Group IT&T), or some combination of the two.

This strategic future direction should be supported by a plan for its implementation.

(e) Prepare contracts for IT delivery. The implementation of SLAs and the movement of IT service delivery to a more commercial footing can provide the foundation for IT services contracts between the Group IT&T entity and each of the companies. Such contracts should specifically address:

• a commitment from each of the operating companies to draw primary IT services from Group IT&T, with defined notice period for termination;

• a mechanism for the operating companies to transition to

alternate/independent delivery models, should they choose to move from a central IT services delivery - however, such a model should recognise that a company moving from the central delivery model must finance a proportionate amount of the stranded cost that remains; and

• ownership of IT infrastructure and systems (including software).

22/08/02 Page 86

Process for Restructuring 10.8.15 The restructuring process in relation to IT services should be consistent with the

overall restructuring process. We recommend:

(a) Initial Stage During the period of preparation for restructuring, a change programme should be

completed to address:

• the implementation of SLAs between Group IT&T and the operating companies;

• the transition to a commercially operated relationship for IT delivery;

• agreed contracts for IT delivery post restructuring; and

• the organisational relocation of Group IT&T and its transition to a Central IT

Service provider. 10.8.16 At the end of this stage, Group IT&T will be transferred into a newly created

central services entity, owned by the operating companies. Each operating company should be committed through the use of SLA’s to utilising the services of Group IT&T for a specific period of time of between 3 and 5 years. This will allow the existing service levels to the operating companies to be maintained without disruption and provide stability for Group IT itself.

(b) Intermediate Stage During this period each of the operating companies will need to undertake an IT

review exercise to assess its strategic direction for IT delivery, recognising that any significant change will take considerable time to implement e.g. if VAX systems need to be replaced or an IT department needs to be created. The central IT service can play a key role in the development of an IT strategy for the operating companies.

(c) Final Stage

Each operating company could be fully empowered to determine how its IT service will be delivered – within the constraints of the notice period defined in the contract. Based on the results of each individual operating company’s strategic plan, the companies may have: • Strategically decided to use Central IT Service for core IT delivery; • Already resolved to change the IT service delivery model/provider and have

served notice in this regard; • Chosen to continue with Central IT Service while it assesses capability and

value for money in the marketplace e.g. a company may undertake a

22/08/02 Page 87

benchmarking exercise between Central IT Service and other IT service providers; or

• Opted for some composite approach within the boundaries of the IT delivery contract.

10.9 Claims management

10.9.1 Issues associated with the Claims Management department are dealt with in Section 6.

10.10 Solicitors department

Description 10.10.1 The solicitors office comprises 22 solicitors and support staff. The work carried out

by the solicitors office is divided into four principal areas as follows:

(a) property; (b) litigation;

(c) commercial; and

(d) specialist advice in relation to public transport law.

10.10.2 The property work primarily relates to property used in connection with the business

carried out by the railway and includes:

(a) general property projects; (b) way leaves/abandonment/level crossing agreements; and

(c) planning and environmental law.

10.10.3 The litigation work relates to a wide variety of issues including:

(a) prosecution of offenders who breach transport laws; (b) personal injuries actions, the majority of which are currently outsourced to the

claims department; and

(c) applications for railway orders and compulsory purchase orders.

10.10.4 The commercial work relates to commercial contracts generally including public private partnership and infrastructure projects. A considerable amount of the commercial work is sub-contracted to external law firms specialising in commercial advice. These law firms were selected on the basis of procurement and tender principles. The main role of the solicitors office in the context of commercial law advice is to manage the interface between CIE and the external lawyers.

22/08/02 Page 88

10.10.5 The specialist advice given in relation to public transport law includes advising on:

(a) European Union legislation affecting issues such as competition in the area of public transport;

(b) national law affecting public transport and competition; and

(c) issues relating to transport-related regulatory agencies i.e. the Railway Safety Commission, the Railway Procurement Agency and the Dublin Transportation Office.

Issues 10.10.6 The main issue is effectively how to manage the allocation of knowledge base, skills

and resources that currently exist in the solicitors office. The key issues to be considered are:

(a) If the operators are restructured as stand-alone companies, they could each undertake litigation and commercial services with the appropriate resource allocation and planning, with support from external lawyers as required.

(b) The decision as to how the property of CIE will be held is the main factor in determining whether there should be a single legal department dealing with all property related legal issues. Alternatively, were property to be allocated to the CIE operating companies, then property advice could be provided by property lawyers in the respective legal departments.

(c) With regard to the specialist advice given in respect of transport law, an assessment will have to be made as to whether this can be replicated in the legal department of each of the CIE operating companies or whether there should be a separate office in a central services company.

(d) We understand that the transfer of the solicitors department from the CIE parent company to a central services company, owned by the operating companies, may present some difficulties under the Solicitors Act, 1954 (Professional Practice, Conduct and Discipline) Regulations, 1955. A literal interpretation of these regulations requires that a solicitor employed by a company for a fixed salary should act as a solicitor for his employer only. We also understand, however, that a waiver from the regulations is possible with agreement in writing of the Council of the Law Society.

22/08/02 Page 89

Options/recommendations 10.10.7 The following options could be considered for the restructuring of legal services:

(a) Option 1: During the initial restructuring period all the functions currently undertaken by the solicitors office could be transferred to a legal department in the group services provider. This legal department could then advise each of the CIE operating companies through a series of arms-length commercial agreements. A more detailed assessment would need to be made as to the practicality of such an arrangement and to resolve certain issues such as the potential for conflicts of interest if there were litigation between any of the CIE operating companies. During subsequent stages of restructuring, the actions identified in options 2 and 3 below could be considered and/or implemented where appropriate.

(b) Option 2: During the initial restructuring period, transfer to a group service provider those specialist services that will be required by all the operators such as those related to public transport law (and property services were property to be retained centrally), whilst the remainder of the core legal services could be transferred to newly created in-house operator legal departments.

(c) Option 3: Each of the CIE operating companies could outsource its legal requirements to external law firms. This option would have to be analysed in the context of cost and the potential to ensure that existing expertise is maintained in the short to medium term.

10.10.8 In light of the issues identified during the review of the CIE solicitors department, the most pragmatic approach to the initial stage of restructuring would be to proceed as described in Option 2. This option will allow the specialist skills identified by both CIE and the CIE operating companies to continue to be shared whilst transferring the remainder to operator management control. If taken forward, this option will need to be addressed in more detail as part of the generic transition plan outlined in section 10.7.

10.11 Property services

Introduction 10.11.1 Property services within CIE parent company can be divided into two separate areas:

(a) property management services provided by the CIE parent company property management department; and

(b) property maintenance services provided by Irish Rail.

22/08/02 Page 90

Property management: Description 10.11.2 Property management services are provided by the CIE parent company central

property department which has a team of 22 staff, made up as follows:

Category Number of staff Surveyors 13 Trainees 3 Other executive/clerical 6 Total 22

10.11.3 The department provides a range of property related services to the CIE operating

companies which includes:

(a) property management;

(b) valuation services;

(c) disposal and acquisition of property; and

(d) management of external rentals.

Property Management: Issues 10.11.4 A number of issues have been identified in relation to the future provision of these

services:

(a) the extent to which each of the operating companies will require such a range of services in the future will depend on the option chosen concerning the allocation of property ownership - Both Dublin Bus and Bus Éireann will have more limited requirements than Irish Rail;

(b) further land acquisition work may be required; and (c) an assessment of the ability to achieve provision of services at greatest efficiency

into the future will need to be completed.

Property Management: Options Option 1. Transfer entire function to a separate property holding entity; or Option 2. Transfer such resource as deemed necessary to each operating company to manage respective property portfolios. This will primarily be to Irish Rail the dominant property occupier and user with subcontract arrangements to Dublin Bus and Bus Éireann.

22/08/02 Page 91

10.11.5 The recommendation as to which option to implement will follow decisions concerning the strategy for the portfolio of property itself i.e. with a new property company or the respective CIE operating companies.

10.11.6 Within the context of future operating environments, each of the CIE operating companies needs to consider the extent of property services they are likely to require, including the market testing of service provision and the feasibility of buying in such services on a contract basis from Irish Rail or the commercial market.

Maintenance Services: Description

10.11.7 Irish Rail provides maintenance services to itself and other CIE group entities. The cost of providing these services is charged back to the operators and the CIE parent company.

Maintenance Services: Issues

10.11.8 Two main issues have been identified in relation to the future provision of these services:

(a) the building maintenance services provided by Irish Rail exist for mainly historic reasons - To date, no commercial benchmarking has been undertaken on the services provided; and

(b) the requirement for continuing the service provision will, in part, be determined

by the options selected for property ownership and management. Maintenance Services: Options (a) Option 1. Maintain the services within Irish Rail, developing more formal

subcontract arrangements with Dublin Bus and Bus Éireann. (b) Option 2. Transfer such resources as deemed necessary to each operating

company to undertake required maintenance. Maintenance Services: Conclusions

10.11.9 In the initial stage, an arms-length agreement could be put in place under which Irish Rail would continue to provide such maintenance services. Such agreement would include provision for both Irish Rail and the bus operating companies over time to cease such arrangements. The objective would be to provide such services at market rates. Where the provision of service is to be terminated then Irish Rail should be given sufficient notice to reduce the overheads associated with the commitment.

10.11.10 The options identified will need to be addressed in more detail as part of the generic plan outlined in Section 10.7.

22/08/02 Page 92

10.12 Group finance and treasury

Description 10.12.1 The Group Finance Department currently has a staff complement of 21, including

the Group Finance Director and the Group Financial Controller roles. The department undertakes the following functions:

(a) Group accounting and consolidation; (b) Group finance strategies;

(c) Group treasury;

(d) CIE parent company payments; and (e) company salaries and pensions for the holding company and operating

companies. 10.12.2 The group accounting and consolidation function undertakes the monthly and

annual consolidation of the three operating companies and the CIE parent company, which are presented to the CIE oard for consideration. The CIE operating companies produce monthly accounts that are transmitted to the CIE parent company for consolidation purposes. The CIE parent company function also has the responsibility of preparing the CIE Group consolidated financial statements. The function also undertakes the accounting for the various group services which reside within the CIE parent company (i.e. Property Department, Claims Department, Marketing Department, Human Resources Department etc.).

10.12.3 The CIE Group finance function is responsible for developing the finance strategy for the CIE Group, in conjunction with the Financial Controllers in the operating companies.

10.12.4 The CIE Group treasury function undertakes the cash resource and debt management for all the operating companies and the CIE parent company. This function has full control over the bank accounts of each of the individual operating companies and effectively extracts cash on a daily basis and manages the cash resources of all CIE companies on a centralised basis. The function also negotiates all debt on behalf of the CIE group and allocates debt and interest costs across the Group companies through an inter-company account structure.

10.12.5 The CIE Group payments function manages payments on behalf of departments and service units that currently reside in the CIE parent company.

10.12.6 The Salaries and Pensions Department manages the payroll on behalf of the CIE parent company and the administration of the pension payroll for approximately 6,500 pensioners from all of the CIE Group companies.

22/08/02 Page 93

Issues/Recommendations

10.12.7 The issue on restructuring of CIE is how to manage the allocation of skills that

currently exist within the Group finance function to the various operating companies. This issue needs to be dealt with for each of the current functions undertaken by the Group finance function noted above.

(a) The CIE Group accounting and consolidation function would be required until the shareholdings in the various operating companies are transferred from CIE to direct ownership by DoT. The CIE Group accounts function will also be required to account for the continuing operations at the CIE parent company until such time as these functions are either transferred to operating companies or a separate central services company.

(b) The CIE Group finance function has a significant role in the development of the

finance strategy of both the operating companies and key central service functions. Following restructuring of CIE, consideration will need to be given to the existing skill sets in each of the operating companies. This process should be carried out in conjunction with newly appointed audit committees in each of the operating companies. The decision will also need to be taken concerning the allocation of the key services functions, such as property, claims management, debt and pensions.

(c) Under the current structure, CIE parent company undertakes all reasury

functions, including cash and debt management. Given the significant debt burden and substantial cash flow generated by the business, this is a complex area and requires careful management. The day-to-day cash management, following restructuring of CIE should be undertaken by the finance teams within the various operating companies. This will require the implementation of new systems to monitor day-to-day cash management and also to forecast cash inflows and outflows at each operating company. It will also require an assessment of the existing finance teams at the operating companies to ensure that they have the necessary skills to undertake this function.

(d) The CIE Group payments function will be required until the various central

services currently provided by the CIE parent company are transferred either to a central services company or to individual operating companies.

(e) The pensions payroll department could either be transferred in conjunction with

the management of the pensions function to one of the operating companies/central services company or outsourced to a payroll services bureau. This decision should be taken having regard both to the cost of service being undertaken and the quality of the service provided. Pensions are currently paid by bank transfer, cheque and cash, and the payment of pensions by cheque and particularly cash could lead to some difficulties in locating an appropriate payroll bureau service. Given the extensive experience and workload, the pensions and payroll department should be included in a Group Services Company.

22/08/02 Page 94

10.12.8 Each of the above issues will need to be addressed in more detail as part of the generic plan identified in Section 10.7.

10.13 Internal Audit

Description

10.13.1 The internal audit department currently has 11 staff, including one contract staff member, and undertakes audit reviews for the CIE parent company and the CIE operating companies.

10.13.2 The nature of the audit reviews undertaken may be categorised under the following headings:

(a) standard internal audit reviews;

(b) systems audits, carried out on EU projects, following standards and schedules prescribed by the Department of Finance;

(c) capital expenditure audits, carried out on a range of EU and National Development Plan projects in accordance with the requirements of the Department of Education, and/or the Department of the Marine; and

(d) schools transport audits for the Department of Education.

Issues 10.13.3 As a consequence of the range of audit work undertaken, the Internal Audit

Department has developed a skills set in a number of specialist areas including IT, EU and National Development Plan Programme funding. This relates to both transaction and systems skills and schools transport and revenue audit skills. While the requirements for some of these skills are specific to individual operating companies, others, such as IT, are required at both the CIE parent company and operating company level.

10.13.4 The internal audit department has a reporting line directly to the CIE Board and

Audit Committee and also to the DoT for specific audit work carried out under agreement between CIE and DoT.

10.13.5 The internal audit department has historically undertaken significant work in

relation to LUAS, although responsibility for this project has now transferred to the Rail Procurement Agency.

10.13.6 The primary issue arising from the proposed restructuring of CIE is to ensure the

continuation of the internal audit service at the levels currently provided. At present the centralised approach allows for the maintenance of specialist skills, which can then be used to meet the audit requirements of the individual companies. A splitting up of the internal audit department with devolvement to the individual operating companies will lead to a diseconomy of skills.

22/08/02 Page 95

10.13.7 A further issue may arise on restructuring concerning the decreased independence of the devolved Internal Audit Departments for the purposes of EU and NDP funded projects.

10.13.8 There will be a requirement to appoint audit committees reporting to the Boards of each of the operating companies, and the internal audit departments should have a direct line of reporting to the Chairmen of each of these audit committees.

10.13.9 Options/Recommendations As a consequence of the diseconomies that may result from a splitting up of the

internal audit department, the options identified below focus on ways of maintaining the service levels of the department:

Option 1: Transfer to the CIE Group services company. The central service

company should provide internal audit services to the operating companies for a predefined period. During this period the bus companies should consider resourcing their own internal audit functions either by recruitment from the existing function where there is considerable experience or from the external market.

Option 2: Transfer the staff and functions of the internal audit department to Irish Rail and put in place arms-length contractual arrangements for the continued provision of relevant services to Dublin Bus and Bus Éireann.

Option 3: Transfer the staff and functions of the internal audit department to each of the operating companies.

Following assessment of the issues identified during the review of the CIE internal audit department, the most pragmatic approach to restructuring would be to proceed as defined in Option 1, at least in the initial stage of restructuring, to be followed by a further review of Option 3 at a later stage. If taken forward, this option will need to be addressed in more detail as part of the generic transition plan outlined in section 10.7.

10.14 Group human resources and personnel

Description 10.14.1 The Group human resources and personnel department comprises 6 staff, who are

responsible for the following functions:

(a) CIE parent company personnel; (b) pension scheme management issues; (e.g. pension scheme communications)

(c) training and development; and

22/08/02 Page 96

(d) administration of the CIE employee travel scheme and sports and social scheme.

Issues 10.14.2 The specific issues identified in relation to Group HR and personnel department are

as follows:

(a) through the change process, there will be a requirement for a human resources function to assist change management with developing and implementing the transition plan;

(b) the impact on the personnel management activities will be largely dependent on

the re-allocation of functions and staff as a result of the restructuring. The extent to which a group services human resources function will be required will be largely dependent on the scope of a central service company;

(c) the treatment of the human resources related aspects of the pension scheme

management will be dependent on the option selected for the Pension Scheme; (d) training and development will be an important element of the restructuring

process itself as well as the future development of the operating companies; and (e) CIE employees currently benefit from a group wide travel scheme.

Management of this scheme will need to be resourced to deal with inter company billing and international rail travel concessions.

Options/recommendations 10.14.3 The following options could be considered for the restructuring of human resources

services:

Option 1: During the initial restructuring period all the functions currently undertaken by the CIE human resources department could be transferred to a human resources team in the group service provider. This human resources department could then provide relevant services to each of the stand-alone entities through a series of arms-length commercial agreements. A more detailed assessment would need to be made as to the practicality of such an arrangement. During subsequent stages of restructuring, the actions identified in options 2 below could be considered and/or implemented where appropriate.

Option 2: Incorporate such resources as deemed necessary to each operating company to manage respective HR requirements, whilst maintaining a central resource to manage the requirements of the group services company requirements.

22/08/02 Page 97

10.14.4 Following assessment of the issues identified during the review of the CIE HR department, the most pragmatic approach to restructuring would be to proceed as defined in Option 2. If taken forward, this option will need to be addressed in more detail as part of the generic transition plan outlined in section 10.7. There will also be a need for HR specialist participation in the change management team, and this will need to be considered in developing the transition plan.

10.15 Group secretary

Description

10.15.1 The Group secretary department comprises 5 staff, who are responsible for the following functions:

(a) Group secretary including secretarial responsibilities, document archiving and managing worker director elections; and

(b) Group insurance management.

Issues

10.15.2 The specific issues identified in relation to the Group secretarial function have been identified as follows:

(a) whilst each of the CIE operating companies currently has its own Company Secretary, the CIE Group Secretary undertakes and has responsibility for many of the statutory secretarial functions across the group companies. If established as independent entities, this responsibility will need to transfer to the operating companies. The structure of this function will need to be considered to ensure that the statutory responsibilities can be maintained throughout the process of restructuring CIE;

(b) whilst the majority of the existing insurance activity relates to Irish Rail, each of

the operators will have a future requirement to manage its own insurance; and (c) worker Director elections are required to be held every four years and the

management of this process will be required in each of the operating companies.

Options/recommendations 10.15.3 The following options could be considered for the restructuring of the Group

Secretarial function:

Option 1: During the initial restructuring period all the functions currently undertaken by the CIE Group secretariat could be transferred to a Group secretariat in the group service provider, which could then provide a service to each of the stand-alone entities. They will also provide secretarial services to the services company. A more detailed assessment would need to be made as to the practicality of such an arrangement, and during subsequent stages of restructuring, the actions

22/08/02 Page 98

identified in option 2 below could be considered and/or implemented where appropriate.

Option 2: Incorporate necessary resources in each operating company to manage statutory secretarial functions and the other activities currently undertaken by the Group secretariat.

10.15.4 Following assessment of the issues identified during the review of the CIE Group secretariat department, the most pragmatic approach to restructuring would be to proceed as defined in Option 2. If taken forward, this option will need to be addressed in more detail as part of the generic transition plan outlined in section 10.7, which will need to ensure that the statutory Group secretarial responsibilities are maintained throughout the process of restructuring CIE.

10.16 Group marketing, media and PR

Description 10.16.1 This function provides a number of services to both CIE Group and the operating

companies. These services are summarised below:

(a) Communications & Marketing Group (“CMG”). The CMG co-ordinates public relations and Marketing for CIE, and includes representatives from each of the three operating companies. CMG defines, co-ordinates and oversees the implementation of Group and operating companies’ communications strategy e.g. the current high-level corporate advertising.

(b) Parent company media and public relations function. The media and public

relations function is responsible for the development of a strategic communications policy within the CIE parent company and the provision of speech and briefing material in line with key messages, as well as providing a media monitoring service to Group and operating companies.

(c) Marketing functions. The Group Marketing function currently includes co-

ordination of Group marketing strategy, management of CIE Group websites, co-ordination of e-commerce activities, customer service research and the implementation and co-ordination of corporate branding.

(d) Representation on Government committees. Group Communications is

currently responsible for reports to DoT and interdepartmental committees relating to publicity for the National Development Plan and ERDF investment, and quality customer service.

22/08/02 Page 99

Issues 10.16.2 A number of specific issues have been identified:

(a) each of the operators currently has a marketing function that focuses solely on their own activities – and the CMG act as a co-ordinating forum to provide consistency in implementation;

(b) much of the current CIE marketing, public relations and media functions can be

transferred (with suitable resource allocation and planning) to each of the operators if they are to be restructured as stand-alone entities reporting directly to DoT. The responsibility for co-ordination of public relations and marketing across the CIE Group (including promotion of public transport, brand and website development) will need to be assessed further to ensure that during the transition period and before the establishment of the relevant regulatory bodies such co-ordination is maintained;

(c) As discussed in Section 3, for an integrated ticketing system to continue there

will be a need for the co-ordinating role currently undertaken by the CIE parent company. We understand that governmental responsibility for integrated ticketing will devolve to the Rail Procurement Agency although the detailed process for this has yet to be determined.

Options/recommendations

10.16.3 The following options could be considered for the restructuring of the Group

marketing, media and public relations function:

Option 1: During the initial restructuring period all the functions currently undertaken by the CIE Group marketing, media and public relations could be transferred to a Group marketing department in the group services provider, which could then provide a service to each of the stand-alone entities. A more detailed assessment would need to be made as to the practicality of such an arrangement, and during subsequent stages of restructuring, the actions identified in option 2 below could be considered and/or implemented where appropriate.

Option 2: Incorporate necessary resources in each operating company to undertake the functions currently undertaken by the Group marketing, media and public relations department.

22/08/02 Page 100

10.16.4 Following assessment of the issues identified during the review of the CIE marketing, media and public relations department, the most pragmatic approach to restructuring would be to proceed as defined in Option 2. If taken forward, this option will need to be addressed in more detail as part of the generic transition plan outlined in section 10.7. This review will need to incorporate the need for co-ordination between operators that may be required prior to the establishment of the relevant regulatory bodies.

10.17 Programmes and projects

Description 10.17.1 The programmes and projects department currently has a staff of 4 executives and

one clerical officer and undertakes the following functions:

(a) applications for EU Grants; (b) assistance in the administration of grant claims carried out in conjunction with

the group finance department and the finance departments in the subsidiary companies;

(c) reporting on both the financial and physical aspects of the various NDP

projects, including the reporting of key monitoring indicators; and (d) attendance on behalf of the CIE Group companies on external committees, such

as the EU Cohesion and Structural Funds monitoring committee, the NDP monitoring committee and the DTO steering committee.

Issues 10.17.2 As a result of our assessment the following main issues have been identified:

(a) the majority of ongoing capital projects are undertaken by Irish Rail, and as a result the bulk of the programmes and projects team activity is related to those projects; and

(b) the main requirement of the team for Dublin Bus and Bus Éireann is the

expertise related to EU grant application and administration.

Options/recommendations 10.17.3 The following options could be considered for the restructuring of the CIE Group

programmes and projects function:

Option 1: The functions currently undertaken by the CIE rogrammes and rojects department could be transferred to the group service provider, which could then provide a service to each of the stand-alone entities. A more detailed assessment would need to be made as to the practicality of such an arrangement, and during subsequent stages of restructuring, the actions identified in option 3 below could be considered and/or implemented where appropriate.

22/08/02 Page 101

Option 2: Transfer the staff and functions of the programmes and projects department to Irish Rail (as the vast majority of ongoing capital projects are undertaken by Irish Rail), and put in place arms-length contractual arrangements for the continued provision of relevant services to Dublin Bus and Bus Éireann. A more detailed assessment would need to be made as to the practicality of such an arrangement, and during subsequent stages of restructuring, the actions identified in option 3 below could be considered and/or implemented where appropriate.

Option 3: Incorporate necessary resources in each operating company to manage the activities currently undertaken by the Programmes and Projects Team. (a) 10.17.4 In light of the issues identified during the review of the CIE Programmes and Projects

Department, the most pragmatic approach to restructuring would be to proceed as defined in Option 3. If taken forward, this option will need to be addressed in more detail as part of the generic transition plan outlined in section 10.7, to ensure that the expertise requirements of all the operators can be accommodated during the restructuring process.

22/08/02 Page 102

11 Ancillary Services

Key Points

• There are two ancillary businesses within the CIE Group, namely CIE Tours and CAN.

• Two options have been identified for CIE Tours:

- Option 1: maintain within state ownership; or - Option 2: divest the assets through either a management buyout or trade

sale

• The divestment of this asset offers the potential to generate cash for the Group, although it will be essential that analysis to verify the financial viability of this option be undertaken prior to any decision.

• Two options have been identified in relation to the advertising contract

managed by CAN:

- Option 1: Continue with central contract; or - Option 2: Transfer to individual operating company contract

• It is recommended that the existing central contract be maintained to

completion, whilst the operating companies complete a review of the benefits of collective negotiation against those of individual operating company management.

11.1 CIE Tours

Description 11.1.1 CIE Tours International (“CIE Tours”) is incorporated in the USA, and is wholly

owned by the CIE parent company. It has three subsidiaries in Ireland, Germany and the UK. CIE Tours has been in existence for approximately 80 years, originally connected to the railway company to encourage rail travel within Ireland. It achieved a consolidated forecast turnover of €54.8m for the year to December 2001.

11.1.2 The company operates in 4 markets – the USA, UK, Germany and Ireland. A summary of these markets and the revenue for each is provided in the table below.

Country Employees (2000) 2001 Revenue forecast (€m) % Ireland 60 6.377 11.6% US 40 41.060 74.9% UK 3 1.856 3.4% Germany 10 5.556 10.1% Total 113 54.849 100.0%

22/08/02 Page 103

11.1.3 Trading has been hit particularly hard in 2001/2002 initially by the foot and mouth epidemic in the UK and subsequently by the events of September 11 2001. Accordingly, the results for 2001 are expected to show an operating profit of €1m (2000 €2.6m).

Issues The review of the business has identified the following main issues:

(a) Whilst CIE Tours is a subsidiary of the CIE parent company, it does not draw up separate accounts. As a result CIE Tours does not have a formal P&L, balance sheet or control of the treasury function. Foreign exchange hedging is important to CIE Tours, for which policy is established by CIE Tours management but day-to-day management of the function is a CIE parent company responsibility.

(b) CIE parent company owns the property occupied by CIE Tours. Unlike other

operating units, CIE Tours rents the property at commercial rate. (c) In addition to the finance functions, CIE Tours is also dependent on CIE Group

Services for payroll, legal claims and insurance, HR policy, IT support and administration services of hardware and non-trade specific software requirements, pensions management.

(d) CIE Tours has its own management accounts systems and produces its own

management accounts. Insurance to customers is provided as a service by CIE Tours.

(e) The CIE Tours inventory allocation booking system (TEX7) is key to the

business, but is not supported by Group IT. (f) Bus Éireann provides a fleet of 18 coaches with drivers to CIE Tours at their

specification for the duration of the summer tourist season. The preservation of this arrangement is important to the continuity of the CIE Tours coach tour business in Ireland. Changes to this also have the potential to affect established agreements with the trade unions.

Options

11.1.4 Notwithstanding the current use of CIE Group Services, CIE Tours is a stand-alone business, independently managed and serving the tourist industry. It is non-core to the CIE business of public transport provision and exists within CIE Group as a result of historical precedent rather than commercial rationale. The CIE Tours brand is strong especially in its core US market and in Ireland.

22/08/02 Page 104

11.1.5 There are a number of options for CIE Tours in the restructuring of CIE Group:

Option 1: Transfer ownership to Bus Éireann or Irish Rail. This would enable CIE Tours to utilise the support services of a larger business providing service stability and reducing the cost impact of creating in-house services. As a subsidiary of Irish Rail the arrangement for the provision of coaches with Bus Éireann could be maintained. Option 2: Management Buy Out (“MBO”). Critical to the viability of an MBO would be the ability of the business to operate on a stand-alone basis with the need to replace the services currently provided by the CIE parent company. Continuity of employment and employment terms would also need to be considered as would the extent of the involvement of CIE Tours’ employees in the future ownership structure of the business. Analysis is required to establish the financial feasibility of the route. Option 3: Trade sale. A trade sale would reduce the need for CIE Tours to resource in-house support services, as it could be assumed that the acquiring company would have capacity to integrate the operation of CIE Tours into its existing business. Continuity of employment and employment terms would be a more significant issue with a trade sale.

11.1.6 Conclusions As a non-core business to the main operations we recommend either option 2 or 3

be developed, although it will be essential that analysis to verify the financial viability of these options be undertaken prior to any decision.

11.2 Commuter Advertising Network

Description

11.2.1 Commuter Advertising Network (“CAN”) is a division of CIE parent company, having been centralised from the operating subsidiaries in 1995. It has a staff of one person. CAN is responsible for the tendering of a contract to manage and develop advertising for the CIE Group. TDI were awarded the initial contract in 1995, which was re-tendered in 2000 and again awarded to TDI (now part of Viacom).

11.2.2 The contract is awarded on a fixed term basis for existing advertising “space” and on a 60/40 (CIE/Viacom) split of profit for new opportunities identified. These new opportunities are developed by Viacom in discussion with CAN and the operating subsidiaries. For example, Dublin Bus has a policy of limiting external advertising on buses to a minority of the bus fleet, in order to reduce the impact of brand dilution.

22/08/02 Page 105

11.2.3 The table below sets out the advertising medium and the revenue attributed to each:

Medium Location 2001 (forecast) €’000 revenues

Revenue generation split

Mobile Buses (external and internal) Trains (external and internal) 2,067 40%

Fixed Billboards Advertising stands 3,100 60%

Total 5,167 100%

11.2.4 25% of profit is retained by the CIE Parent Company and the remainder is split

broadly 50% to Irish Rail, 40% to Dublin Bus, 5% to Bus Éireann with the remainder allocated to CIE parent company.

11.2.5 Each of Dublin Bus and Bus Éireann is responsible for maintaining advertising on buses its (internal and external), but Viacom is responsible for maintaining and posting of fixed site advertisements (mainly track side advertising). CAN carries out comprehensive audits of both the fixed sites and mobile sites, and also relies on feedback from the operators such as Irish Rail workers monitoring conditions of track side advertising.

Issues 11.2.6 The CAN business is effectively stand-alone but relies on the following CIE Group

Services:

- solicitors department for contract negotiation;

- IT systems (e.g. server network; email);

- CIE Finance for CAN accounts; and

- property charges CAN for use of sites.

11.2.7 Restructuring has a potential risk if the contracts are subdivided. At present CIE provides a major portfolio of advertising and bargaining power which will be reduced if this portfolio is spread across all subsidiaries, media and geographic location.

11.2.8 Planning permission is required for constructing new billboards, but rail, bus station, airport terminal are exempt from planning. This allows extended freedom to the operators to exploit fully the use of their assets to generate advertising revenue.

11.2.9 CAN is not responsible for advertising on bus shelters, the responsibility for which lies with Dublin Bus and Bus Éireann. If the CAN contract were to be sub-divided as a result of restructuring, there is potential for Dublin Bus and Bus Éireann to combine the existing CAN advertising portfolio with their existing bus shelter portfolio potentially reducing any scale reduction impacts of splitting the existing CIE portfolio.

22/08/02 Page 106

Options

11.2.10 The two options for the existing CAN contract are:

(a) Option 1: Maintain central contract. The existing contract is two years into a 5 year term. This existing contract could be maintained, with CAN re-located to a central services group, and all profits distributed to the operators as per the existing arrangement. On completion of the current contract the CIE operating companies could continue to negotiate collectively.

(b) Option 2: Devolve responsibility to the CIE operating companies This

would involve the transfer of advertising responsibility to the operators providing them with the opportunity to market their own sites. This would result in the operators managing a non-core business, and may reduce the scale impact of the CIE portfolio and reduce its negotiating position, potentially diminishing the terms. It would however provide the CIE operating companies with commercial independence to manage assets more directly.

Conclusions

11.2.11 We recommend the following actions to be undertaken. 1. maintain the current central contracts to completion; and

2. the CIE operating companies to complete a review of the benefits of collective

negotiation against those of individual operating company management and direct control of revenue and profit risk sharing.

22/08/02 Page 107

12 Phasing issues for implementation Key Points Three stages of restructuring are envisaged:

• Stage 1: “Initial” restructuring, initial steps to enable a restructuring to commence at a sub-optimal level. This should commence prior to the introduction of new legislation, which will be necessary to effect the restructurings of the CIE Group .

• Stage 2: “Intermediate” restructuring, which would achieve a sustainable commercial model in public ownership but maintain flexibility to accommodate future developments in regulation and policy. This would happen on enactment of new legislation and vesting of assets/liabilities in operating companies.

• Stage 3: "Final” restructuring, over time there will be a need to accommodate future policy developments as envisaged in the Red Book. This would evolve with the implementation of new regulatory regimes. At this stage each of the operating companies would be sustainable commercial enterprises capable of providing a return on a defined asset base.

12.1 Introduction

12.1.1 In Section 3 of this report we identified the traits of a sustainable model for restructuring of CIE that would enable the businesses to move forward as the industry evolves. We also acknowledged that it would be unlikely that this model of restructuring could be achieved in one stage. Accordingly, during the course of this report, in discussing issues concerned with restructuring, we have endeavoured to single out options for “Day One” to enable the process to commence. We recognise that achievement of this “preparatory” phase will not result in a completed process and will not be optimal in terms of the nature of the restructured industry.

12.1.2 In this section we bring together options for restructuring that have been identified in earlier sections of this report and set them out in a holistic sense to consider the overall plan for the implementation of measures to achieve the restructuring.

12.1.3 The drivers of this phasing come from a number of sources. Largely, it is the development of the regulatory and statutory environment that will determine the pace at which the restructuring may be achieved. However, the process of change which the operating companies themselves must undergo and the practical constraints of the mechanical and structural aspects of restructuring (for example, the requirement for new legislation and the development of commercial contractual arrangements) will also determine the speed with which restructuring may be achieved.

22/08/02 Page 108

12.2 Overall approach to implementation

The outline approach that could be adopted for the restructuring process is developed in more detail in sections 12.3 to 12.5. The approach comprises three stages of restructuring, each including a period of planning and implementation, however, prior to the commencement of the initial restructuring the following key steps need to be undertaken:

1. appointment of change managers in CIE Holding company and in each of the operating companies;

2. development of an outline restructuring plan for both CIE holding company and

the operating companies - these outline plans will require approval by the respective company executive teams, boards and the DoT;

3. development of a communication plan of the restructuring to all key

stakeholders.

12.3 Stage 1 -“Initial” restructuring

12.3.1 The objective of this initial stage is to enable restructuring to commence and enable the required legislation to be introduced. It recognises that not all measures that might be considered necessary or even desirable in the longer term, would be achieved at this stage. In a pragmatic sense it moves the industry forward and paves the way for further development and refinement under Stage 2.

12.3.2 It is worth noting that the actions envisaged in this stage affect all entities within the Group concurrently. To accommodate the proposals identified in the Red Book it may be appropriate to advance one or more of the operating companies to the next stage more rapidly than others, for example, the development of Dublin Bus in preparation for route franchising. The change management process will be an integral part of Stage 1 and details of the requirements have been described in Section 10 of this report. Enabling legislation would be required at the end of this phase to enable restructuring to proceed and facilitate subsequent phases. This will also require consideration of the implications of section 14(7) of the Transport (Re-organisation of Córas Iompair Éireann) Act, 1986.

22/08/02 Page 109

Preparation for Stage 1 “Initial” Restructuring

12.3.4 In preparation for Stage 1 “Initial” Restructuring, there are a number of

interdependent decisions/approvals required to be taken to enable a detailed restructuring plan to be developed. These are as follows:

(a) a decision by Government to proceed with preparation of necessary

legislation; (b) the Group and each operating subsidiary should be requested by

Government to prepare a detailed implementation plan to effect the necessary restructuring;

(c) appropriate assumptions for a 5 year financial plan which include fares

policy, operating subvention, service levels and capital programme should be agreed;

(d) the levels of group debt should be reduced by at least the amount of Irish

Rails core debt of approximately €170m; (e) the most appropriate ownership structure for key operational properties

in the Group should be decided - this will involve a legal review of all issues, associated with transfer of operating property within the CIE group, including title and EU law issues.

12.3.5 Following the above decisions/approvals, detailed planning is required:

(a) to assess the likely medium term impact of restructuring on the global

level of subvention and capital expenditure requirements; (b) to develop initial fares policy, ahead of a formal regulatory regime, to

provide the operating companies with a framework within which to operate;

(c) to develop and implement a more detailed service specification which

should include monitoring and incentivisation mechanisms. Commensurate with this is a commitment from Government to greater certainty concerning future levels of subvention to permit longer term planning by the operating companies;

(d) to commence a change management process including detailed

assessment of each functional area of the CIE Group Services and resource requirements of each operating company;

(e) to prepare 5 year financial plans including cashflow projections, so that

an initial view may be taken concerning the capacity of each operating entity for debt funding and their requirement for working capital facilities.

22/08/02 Page 110

12.4 Stage 2 –“Intermediate” restructuring

Legal structure/ownership 12.4.1 Following introduction of the required legislation, ownership of the three operating

companies would be transferred from CIE parent company directly to DoT. CIE parent company would remain under ownership of DoT until dissolved. CIE could also continue to own CIE Tours.

Figure 12.1: Potential future structure 12.4.2 This is a model for the industry as described in some detail in Section 3 of this

Report. This model should include, inter alia, the following traits for each operating company:

(a) an appropriately constituted board; (b) independent management teams;

(c) detailed definition by DoT of the services to be provided;

(d) definition of the asset base, initially by the operating companies, required to

provide those services;

(e) creation of an efficient funding structure;

(f) independent fares policy which is linked to operating subvention;

(g) the setting of financial targets by DoT with the support of agreed levels of subvention; and

(h) arms-length agreements to be negotiated with other operating companies, as

appropriate, re access to property, group purchasing arrangements and other services.

Government(Department of Public Enterprise “DPE”)

IarnrodEireann

“Irish Rail”


Bus Atha Cliath



Government(Department of Transport “DoT”)

IarnrodEireann

“Irish Rail”


Bus Atha Cliath



22/08/02 Page 111

12.4.3 It achieves a sustainable model for the three operating companies under public ownership as independent semi-state companies but with flexibility to accommodate future developments in regulation and policy. Importantly it establishes the operating companies in such a way that value for money can be assessed for the taxpayer but equally permits benchmarking of financial returns against the private sector. It is recognised that the eventual form of the regulatory environment (notably in Dublin Bus’s market) may result in a parcelling up of the business in preparation for the introduction of route franchising. This may result in fairly major changes to this part of the industry.

12.4.4 Dependent on the development inter alia of the regulatory environment it may be appropriate to advance one or more of the operating companies to this stage ahead of the other operating companies.

12.5 Stage 3 –“Final” restructuring

12.5.1 Stage 3 takes the operating companies to the eventual operating environment within the regulatory regime as so formed. For example, this may include the introduction of competition by route franchising for Dublin Bus’s markets, while Irish Rail remains in public ownership. It would have the potential to accommodate the introduction of private sector involvement in the industry, which could range from the provision of financing through to ownership of assets.

22/08/02 Page 112

12.6 Restructuring summary

12.6.1 The staged approach to restructuring is shown in the figure below. The key issues

that will need to be determined at each stage and the relative timing of the key milestones to be achieved through the restructuring process are also indicated. For each of the three stages the steps identified in section 10.3 should be completed to assist the process of restructuring.

Figure 12.2: The restructuring route map

Key drivers of restructuring

12.6.2 The table below summarises the options and conclusions set out in each of the

sections of this report concerning the key drivers of restructuring at each stage of the restructuring process.

Key Driver Stage 1 Stage 2 Stage 3 “Initial” “Intermediate” “Final” Subvention Address issues of:

• Public Service Regime with longer term commitment to payment of subvention

• Planning for capital projects

• Set out an initial fare policy

Address issues of: • Full fare policy within

new regulatory framework.

• Impact of regulation and legislation as it becomes known.

Move to integrated structure capable of demonstrating value for money.

Property Further assessment of options: • Option 1: transfer

ownership to the operating companies;

Develop optimal structure for property ownership.

• All operating companies to have access over property whilst preserving value for government

EnactInitial

legislation


Objectives



environment




planning



•5 yr plan













•Vfm evaluation






management


entities




legislative reforms

EnactInitial

legislation


Objectives



environment




planning



•5 yr plan













•Vfm evaluation






management


entities




legislative reforms

22/08/02 Page 113

or • Option 2: maintain the

property in a central holding entity.

• Constraints on usage and claw back arrangements to be implemented where applicable

Debt Develop an optimal balance between the repayment of debt and the allocation of some/remainder of debt to each operating company

Move to efficient level of funding for operating companies.

Separate operating companies financed with efficient capital structures.

Claims Continue to self insure Potential to develop strategy concerning further options: • establish a direct

writing captive insurance company

• seek third party underwriting

Optimal structure for developed.

Pensions Continued participation in existing schemes.

Continued participation in existing schemes.

Potential to create and administer separate schemes.

Central Services

See below See below See below

Central Services

12.6.3 Whilst a more detailed assessment will be required for each function as discussed in

Section 10, the table below provides a summary of the allocation recommendations for each of the existing CIE Central Service functions at each stage of the proposed restructuring process.

12.6.4 In developing this process the Group should seek to retain critical mass efficiencies where possible through shared services arrangements, at least in the short to medium term. This approach is in keeping with best practice adopted by many large national and international businesses. To facilitate the prompt implementation of the restructuring plan we recommend the formation of a Group Service Company to succeed to some of the services currently provided by the holding company. This approach ensures critical mass in certain key areas thus maintaining a value for money approach.

12.6.5 The Group Service Company should be proportionately owned by the operating companies. The current functions undertaken by CIE Holding Company should then either be transferred into the Group Service Company or directly into the operating company as summarised in the table below. We would envisage that the transfer to the operating companies would take place on a phased basis thus allowing for a smooth transition and ensuring continuity of services to the operating company throughout the period of change.

22/08/02 Page 114

Function Initial Stage Intermediate Stage Final Stage Pensions management (inc pension payroll) Claims management IT Services Internal Audit

Services to be provided by group services company.

• Strategic review of IT and Internal Audit completed - could be sourced by alternative provider (in-house or outsourced).

• Pensions and Claims management more likely to be maintained as part of GSC at this stage.

As industry structure is developed in more detail, strategic management review of all functions completed and optimal provider for services identified.

Finance & Treasury HR




Programmes & Projects Group Secretary Marketing & PR Solicitors

• Core functions to be devolved to operators.

• Retention of shared access to specialist expertise during transition period to be assessed further.



Property management

Further detailed assessment required to determine allocation.



Your Worlds Our People

Documents

Department ofTransport Research Study into the … ofTransport Research Study into the financial and other implications of a proposed restructuring of the CIE companies 22 August 2002