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The Fourth Railway Package: the Governance Structure and the Unsolved Problem of Vertical Integration

Monica Delsignore

The Fourth Railway Package is a set of six legislative texts designed to finalize the establishment of the Single European Railway Area. Since 2001, the Eu-ropean Commission has enacted a series of «Railway Packages» with the aim of enabling privately owned train operators to access the European rail market on a competitive basis. The separation of train operators and infra-structure managers is often considered to be a prerequisite for the authentic competition in passenger rail operations. However, the latest step in the EU legislative process, the Fourth Railway Package, does not make the final leap of requiring full separation between train operators and infrastructure managers. Moreover, the Government of the UK, which has one of the most liberalized rail markets in Europe, has announced the possible combination of train operations and infrastructure management known as «vertical integration». The paper will deal with these problematic issues, even focusing on comparative experiences in different Member States.

PAROLE CHIAVE: The Fourth Railway Package - Vertical Integration - Problem - Governance Structure Unsolved

    

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Sommario:

1. The long path to EU railway liberalization - 2. Modes of competing in the railway sector and governance structure of railway operators - 3. The Court of Justice and its jurisprudence on the structure of governance - 4. The new provisions in the Fourth Package: a compromise solution - 5. The predictable effects of the Fourth Package - 6. The separation of infrastructure manager and service providers: suggestions from different experience in other network markets - NOTE


1. The long path to EU railway liberalization

Introducing competition into European railway transport is an ongoing and challenging issue. Since 2002, the European Union has started the path of liberalization [1]. The First Railway Package laid the foundations by requiring operational separation of the functions of infrastructure management, on one side, and of train operations, on the other. The Second Railway Package (2004) and the Third Railway Package (2007) made incremental gains towards full liberalization in freight and international passengers transport.  Specifically, the Second Railway Package provided for the creation of a dedicated Authority, the European Union Agency for Railways (ERA), in the belief that the simultaneous pursuit of the goals of railway safety and interoperability requires substantial technical work led by a specialised body. The objective of the Agency «shall be to contribute, on technical matters, to the implementation of the Community legislation aimed at improving the competitive position of the railway sector by enhancing the level of interoperability of railway systems and at developing a common approach to safety on the European railway system, in order to contribute to creating a European railway area without frontiers and guaranteeing a high level of safety» (art. 1 Reg. EC no. 881/2004, repealed and replaced by Reg. (EU) 2016/796). The intervention of European law, through the first three Packages, moves gradually to the open market in the railway sector. Despite this framework, the majority of rail passenger services in Europe have, until recently, remained largely in the hands of state-owned operators. Many continue to be so. This has led the European Commission to litigate with Member States for infringing the Directives in the three Packages. The subsequent several Court of Justice’s judgements [2] did not clarify the general framework and required for new provisions on the State duties and obligations, which finally lead to the adoption of a new package, the Fourth Railway Package. The Fourth Railway Package [3] contains important changes designed to improve the functioning of the single European railway area through amendments by way of recast to Directive 2004/49/EC and Directive 2008/57/EC, both of which are directly linked to the tasks of the Agency. Those Directives provide in particular for the performance of tasks relating to the issuing of vehicle authorisations and safety certificates at [continua ..]

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2. Modes of competing in the railway sector and governance structure of railway operators

As clarified [5], three possible modes of competition can exist in the railway sector: – Competition «in» the market between vertically integrated companies. In this case, at least two competitive infrastructures exist (i.e. two rail lines with similar paths). This kind of competition has historically existed in Europe [6] and is the predominant form of competition in the US; – Competition «in» the market between competing train operating companies using the same infrastructure. The final consumer can choose between different options for a similar service. This kind of competition, also called «open access competition», exists today in the airlines and in the telecommunication industries. Another important feature of railway open access competition is the fact that service providers would do not receive any State subsidies and would be free to determine their train schedule; – Competition «for» the market. In this case, different train operating companies tender for service provision. The winning company is then entitled to a monopoly for a time-limited franchise defined for a specific area and /or a specific service. This kind of competition can be found in other industries such as water distribution or garbage collection. In the European context, the Fourth Package plans the opening of the market for regional transport around franchises (competition «for» the market). On the contrary, competition for long distance services – at least for profitable services – should be «open access» (or competition «in» the market). Specifically, the regulation of access alone is often not enough to avoid opportunistic or discriminatory behaviour of the network operator. This is especially true when the network operator is included in a group together with companies involved in the rail service distribution. The provisions on unbundling, c.d. unpacking, aim to avoid possible conflicts of interest between the managing body and the supplying companies. European Union Packages should entail the overcoming of a vertically integrated structure (which concentrates network management and transportation service into one subject), in favour of a new model with three poles: State, exclusive manager of the network infrastructures, companies competing for the railway transportation services. This [continua ..]

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3. The Court of Justice and its jurisprudence on the structure of governance

Since 2008 European Commission opened multiple infringement procedures against different Member States on the correct implementation of Railway Packages. One of the most tough issues at stage was the structure of governance of the service operator, particularly concerning the role reserved to the infrastructure owner. The Court stated that the previous Directive required «only that the accounts for business relating to the provision of transport services by railway undertakings be kept separate from the accounts for business relating to the management of the rail infrastructure, since business relating to the provision of transport services by railway undertakings and business relating to the management of rail infrastructure may be kept separate by means of the organisation of distinct divisions within a single undertaking, as is the case with a holding company … in order to guarantee equitable and non-discriminatory access to rail infrastructure, Member States are to take the measures necessary to ensure that the essential functions … are entrusted to bodies or firms that do not themselves provide any rail transport services and that this objective must be shown to have been achieved, regardless of the organisational structures established» (C-556/10, judgement par. 55). The holding company model, and therefore the presence of a parent company and its subsidiaries, is not per se condemned by the Court: it must not be presumed that the holding company effectively exercises economic control over its subsidiary, the infrastructure manager entrusted with essential functions. «The mere fact that the holding company owns a majority or all of the shares or voting rights in the entity entrusted with essential functions is not sufficient, otherwise the ‘normal’ holding company system would be outlawed» (C-555/10, opinion par. 88). In the reasoning of the Court the Railway Packages provisions let most of the railway operators still have strict connection and be influenced by the railway owners. Therefore, the European Commission, even in the light of this jurisprudence, started a new dialogue for emending, above all, the governance structure in the packages in order to find the best solutions for the implementation of a single railway market.

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4. The new provisions in the Fourth Package: a compromise solution

The latest step in the EU legislative liberalization process, the Fourth Railway Package, opted not to require full separation between train operators and infrastructure managers, as many were expecting. Specifically, the amendments to the 2012 Directive retain the concept that network capacity (i.e. train path) allocation and responsibility for setting the charges for access to infrastructure must be kept separate, but expressly acknowledge that the required separation can be achieved within a vertically integrated structure. This concession was the product of a hard battle by a number of Member States, given that the abundant literature on the subject is still inconclusive regarding the impact of separation on the overall system. Vertical integration is therefore permitted rather than outlawed, but with a clear set of safeguards. In fact, the Directives introduce the so called «Chinese wall» arrangements [7], prescribing strict safeguards to protect the independence of the infrastructure manager with an oversight process enacted by the Commission to ensure that a genuine level playing field for all railway undertakings is put in place. The key question is how much regulation and Chinese wall can be effective in the presence of such a strong public property of infrastructures and of such a frequent admixture of infrastructure manager in railway undertaking, considering this is the usual framework in most Member States. The Fourth Package deals with this question but finally offers a compromise solution. As previously noted, the Directive EU 2016/2370, moving from the recalled previous jurisprudence, introduces specific further requirements to ensure the independence of the infrastructure manager. Member States should be free to choose between different organisational models, ranging from full structural separation to vertical integration, subject to appropriate safeguards to ensure the impartiality of the infrastructure manager as regards the essential functions, traffic management and maintenance planning. The Directive offers a specific definition of «vertically integrated undertaking», which means «an undertaking where, within the meaning of Council Regulation (EC) No 139/2004 (*): (a) an infrastructure manager is controlled by an undertaking which at the same time controls one or several railway undertakings that operate rail services on the infrastructure manager's network; (b) an [continua ..]

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5. The predictable effects of the Fourth Package

Accordingly, the impact of the Fourth Railway Package should differ across the EU, depending in part upon the current state of liberalisation in the relevant Member State and in part upon the different choices of the relevant Member State in the implementation of those separation requirements.  In Italy [8] article 37 of law no. 214 /2011 established ART, Autorità di Regolazione dei Trasporti, a new independent technical agency with specific tasks in defining the conditions for access to railway infrastructure [9]. As well known, in Italy the infrastructure manager is RFI, an undertaking controlled directly by the State and vertically integrated with FS, a railway undertaking of total public property. Since July 2018 RFI has incorporated Cento Stazioni, the owner of the station infrastructure. This framework has helped in creating a competitive market for high speed rail [10]. Nevertheless, the same framework has been criticised in the past and the holding company FS has been fined by the Italian Competition Authority for the abuse of its dominant position in the distribution of access to the railway infrastructure [11]. The vertically integrated structure of FS will stay still with no new adjustments due to the Fourth Package.  The new independent Authority should be able to introduce new stringent parameters in order not only to open the infrastructure to new undertaking, but even to improve in quality and frequency of rail services, and finally ensure greater overall passenger satisfaction. The Italian model recalls the German Framework. The infrastructure manager in Germany remains a subsidiary of Deutsche Bahn, a position which the German Government has been keen to protect. The infrastructure manager is split into two parts: one responsible for the rails, the other for the station infrastructure. With over 33,000 kilometres of track under its control, DB Netz AG owns and manages the longest rail network in Europe. Meanwhile, DB Station & Service AG operates the station infrastructure and some of the station buildings at almost all of the passenger stations in Germany. Access to the rail infrastructure on a non-discriminatory basis is supervised by the German Federal Network Agency (Bundesnetzagentur). DB Netz AG and DB Station & Service AG are subsidiaries of state-owned Deutsche Bahn AG, but they do not operate passenger transport [continua ..]

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6. The separation of infrastructure manager and service providers: suggestions from different experience in other network markets

Other network markets can offer previous and different experience regarding the issue of separation. The electricity and ICT are open and competitive markets with transparent governance framework and non-discriminatory rules and both these sectors have faced similar concerns as railways [16]. In all of these sectors the presence of a tradition of State monopolies raised issues about the preferable framework of the new liberalise market in terms of network ownership. Large and integrated firms can often enjoy considerable economies of scope, of scale or of coordination depending on the degree of conglomerate (e.g., multi-product or multi-service), horizontal or vertical integration. This (supposed) pursuit of efficiency may sometimes be at the expense of competition, in that large firms are likely to acquire a strong if not dominant market position. Energy sectors display considerable problems of this type, especially as most of the times their current set-up has its origin in a long tradition of State monopolies, where horizontal as well as vertical integration were the rule. Therefore, as in the railway sector, the access to the transport and distribution infrastructures is a fundamental piece in the design of liberalization in energy markets. Overall, the need of access regulation seems a long run necessary solution for energy markets. Without proprietary separation the network owner has very high incentives to preclude, or at least limit, the access of competitors in the downstream market, vanishing the perspectives of liberalization. Once proprietary unbundling is introduced, the incentives are diminished, and in some cases an ex-post antitrust intervention might be sufficient, but still the possibility of foreclosure remains high [17]. The former de facto monopolistic structure of the Italian electricity and gas markets, which were managed by ENEL and ENI respectively, underwent significant changes following the liberalisation process and the introduction of unbundling obligations on vertically integrated energy operators at the beginning of 2000. In transmission and dispatching, ENEL transferred the ownership of the national grid to a newly established company, Terna, and the management of the grid to another newly established one, Gestore della Rete di Trasmissione Nazionale (GRDN, later renamed Gestore dei Servizi Elettrici) that would guarantee access to the network to any third [continua ..]

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NOTE

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