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The Chinese walls between infrastructure managers and rail operators as a compromise between railway liberalization and State monopolies

Davide Maresca

Proposal for a
DIRECTIVE OF THE EUROPEAN PARLIAMENT
AND OF THE COUNCIL

amending Directive 2012/34/EU of the European Parliament and of the Council of 21 November 2012 establishing a single European railway area, as regards the opening of the market for domestic passenger transport services by rail and the governance of the railway infrastructure

(Extract)

Article 1

Directive 2012/34/EU is amended as follows:

(…)

3. Article 7 is replaced by the following:

Article 7

Institutional separation of the infrastructure manager

1. Member States shall ensure that the infrastructure manager performs all the functions referred to in Article 3(2) and is independent from any railway undertaking. To guarantee the independence of the infrastructure manager, Member States shall ensure that infrastructure managers are organized in an entity that is legally distinct from any railway undertaking.

2. Member States shall also ensure the same legal or natural person or persons are not allowed:

(a) to directly or indirectly exercise control in the sense of Council Regulation (EC) No 139/200410, hold any financial interest in or exercise any right over a railway undertaking and over an infrastructure manager at the same time;

(b) to appoint members of the supervisory board, the administrative board or bodies legally representing an infrastructure manager, and at the same time to directly or indirectly exercise control, hold any financial interest in or exercise any right over a railway undertaking;

(c) to be a member of the supervisory board, the administrative board or bodies legally representing the undertaking, of both a railway undertaking and an infrastructure manager;

(d) to manage the rail infrastructure or be part of the management of the infrastructure manager, and at the same time to directly or indirectly exercise control, hold any financial interest in or exercise any right over a railway undertaking, or to manage the railway undertaking or be part of its management, and at the same time to directly or indirectly exercise control, hold any interest in or exercise any right over an infrastructure manager.

3. For the implementation of this Article, where the person referred to in paragraph 2 is a Member State or another public body, two public authorities which are separate and legally distinct from each other and which are exercising control or other rights mentioned in paragraph 2 over the infrastructure manager, on the one hand, and the railway undertaking, on the other hand, shall be deemed not to be the same person or persons.

4. Provided that no conflict of interest arises and that confidentiality of commercially sensitive information is guaranteed, the infrastructure manager may subcontract specific development, renewal and maintenance works, over which it shall keep the decision-making power, to railway undertakings or to any other body acting under the supervision of the infrastructure manager.

5. Where on the date of entry into force of this Directive, the infrastructure manager belongs to a vertically integrated undertaking, Member States may decide not to apply paragraphs 2 to 4 of this Article. In such case, the Member State concerned shall ensure that the infrastructure manager performs all the functions referred to in Article 3(2) and has effective organisational and decision-making independence from any railway undertaking in accordance with the requirements set in Articles 7a to 7c.’

4. The following Articles 7a to 7e are inserted:

Article 7a

Effective independence of the infrastructure manager within a vertically integrated undertaking

1. Member States shall ensure that the infrastructure manager shall be organized in a body which is legally distinct from any railway undertaking or holding company controlling such undertakings and from any other legal entities within a vertically integrated undertaking.

2. Legal entities within the vertically integrated undertaking that are active in railway transport services markets shall not have any direct or indirect shareholding in the infrastructure manager. Nor shall the infrastructure manager have any direct or indirect shareholding in any legal entities within the vertically integrated undertaking active in railway transport services markets.

3. The infrastructure manager’s incomes may not be used in order to finance other legal entities within the vertically integrated undertaking but only in order to finance the business of the infrastructure manager and to pay dividends to the ultimate owner of the vertically integrated company. The infrastructure manager may not grant loans to any other legal entities within the vertically integrated undertaking, and no other legal entity within the vertically integrated undertaking may grant loans to the infrastructure manager. Any services offered by other legal entities to the infrastructure manager shall be based on contracts and be paid at market prices. The debt attributed to the infrastructure manager shall be clearly separated from the debt attributed to other legal entities within the vertically integrated undertaking, and these debts shall be serviced separately. The accounts of the infrastructure manager and of the other legal entities within the vertically integrated undertaking shall be kept in a way that ensures the fulfilment of these provisions and allows for separate financial circuits for the infrastructure manager and for the other legal entities within the vertically integrated undertaking.

4. Without prejudice to Article 8(4), the infrastructure manager shall raise funds on the capital markets independently and not via other legal entities within the vertically integrated undertaking. Other legal entities within the vertically integrated undertaking shall not raise funds via the infrastructure manager.

5. The infrastructure manager shall keep detailed records of any commercial and financial relations with the other legal entities within the vertically integrated undertaking and make them available to the regulatory body upon request, in accordance with Article 56(12).

Article 7b

Effective independence of the staff and management of the infrastructure manager within a vertically integrated undertaking

1. Without prejudice to the decisions of the regulatory body under Article 56, the infrastructure manager shall have effective decision-making powers, independent from the other legal entities within the vertically integrated undertaking, with respect to all the functions referred to in Article 3(2). The overall management structure and the corporate statutes of the infrastructure manager shall ensure that none of the other legal entities within the vertically integrated undertaking shall determine, directly or indirectly, the behaviour of the infrastructure manager in relation to these functions.

2. The members of the management board and senior staff members of the infrastructure manager shall not be in the supervisory or management boards or be senior staff members of any other legal entities within the vertically integrated undertaking. The members of the supervisory or management boards and senior staff members of the other legal entities within the vertically integrated undertaking shall not be in the management board or be senior staff members of the infrastructure manager.

3. The infrastructure manager shall have a Supervisory Board which is composed of representatives of the ultimate owners of the vertically integrated undertaking. The Supervisory Board may consult the Coordination Committee referred to under Article 7d on issues under its competence. Decisions regarding the appointment and renewal, working conditions including remuneration, and termination of the office of the management board members of the infrastructure manager shall be taken by the Supervisory Board. The identity and the conditions governing the duration and the termination of office of the persons nominated by the Supervisory Board for appointment or renewal as members of the management board of the infrastructure manager, and the reasons for any proposed decision terminating the office, shall be notified to the regulatory body referred to in Article 55. Those conditions and the decisions referred to in this paragraph shall become binding only if the regulatory body has expressly approved them. The regulatory body may object to such decisions where doubts arise as to the professional independence of a person nominated for the management board or in the case of premature termination of office of a member of the management board of the infrastructure manager.

Effective rights of appeal to the regulatory body shall be granted for members of the management board who wish to enter complaints against the premature termination of the office.

4. For a period of three years after leaving the infrastructure manager, members of the Supervisory Board or management board and senior staff members of the infrastructure manager shall not be entitled to hold any senior position with any other legal entities within the vertically integrated undertaking. For a period of three years after leaving those other legal entities within the vertically integrated undertaking, their supervisory or management boards’members and senior staff members shall not be entitled to hold any senior position with the infrastructure manager.

5. The infrastructure manager shall have its own staff and be located in separate premises from the other legal entities within the vertically integrated undertaking. Access to information systems shall be protected to ensure the independence of the infrastructure manager. Internal rules or staff contracts shall clearly limit contacts with the other legal entities within the vertically integrated undertaking to official communications connected with the exercise of the functions of the infrastructure manager which are also exercised in relation to other railway undertakings outside the vertically integrated undertaking. Transfers of staff other than those referred to under point (c) between the infrastructure manager and the other legal entities within the vertically integrated undertaking shall only be possible if it can be ensured that sensitive information will not be passed on between them.

6. The infrastructure manager shall have the necessary organizational capacity to perform all of its functions independently from the other legal entities within the vertically integrated undertaking and shall not be allowed to delegate to these legal entities the operation of these functions or any activities related to them.

7. The members of the supervisory or management boards and senior staff of the infrastructure manager shall hold no interest in or receive any financial benefit, directly or indirectly, from any other legal entities within the vertically integrated undertaking. Performance-based elements of their remuneration shall not depend on the business results of any other legal entities within the vertically integrated undertaking or any legal entities under its control, but exclusively on those of the infrastructure manager.

PAROLE CHIAVE: chinese walls - infrastructure managers - operators - compromise - railway liberalization - state monopolies

Sommario:

1. Introduction: the growing period of rail liberalization: from the nineties to the first package - 2. The innovations of the first package: organizational separation, capacity allocation and independent regulation - 3. The paradox of further railway packages: internal market rules as the legal basis for the harmonization of technical and safety requirements - 4. From rationalization to compromise: approval of the fourth railway package - 5. Overview of the fourth railway package - 6. Opening up domestic passenger markets and centralization of safety certificates: the innovations of the fourth package - 7. The 'heart' of the fourth package: the institutional separation between the infrastructure managers and transport operators - 8. Conclusion: Chinese walls as a compromise between institutional separation and holding companies - NOTE


1. Introduction: the growing period of rail liberalization: from the nineties to the first package

While it is, formally, possible to assert that the rail industry has already been liberalized [1], a more specific analysis highlights a fluctuation of the policies that lead to a compromise: the introduction of informational barriers (“Chinese walls”) between infrastructure managers and rail operators [2]. Since the negotiations for the Treaty of Rome, two rail transport policies were opposed in the Council of Europe [3]. Traditionally speaking, the Dutch preferred a free market access policy while France [4], Germany [5] and Italy, because of the low density of their territories, wanted a strong public intervention in the land transport economy for both trucks and trains [6]. Despite those contrasts, the majority of the Member States decided to begin to completely open up transport markets through the adoption of specific legislative acts. Nevertheless, the earliest Commission proposals were not approved by the Council of Ministers due to the continuation of the monopolized system of rail network. This situation led to a judicial controversy between the Parliament [7] and the Council before the European Court of Justice. The objective was to force the Council to approve the Commission proposals. The European Court of Justice [8], first of all, declared that «under Article 175 the Court must find that there has been an infringement of the Treaty if the Council or the Commission fails to act when under an obligation to do so». In conclusion, the Court declared «that in breach of the Treaty the Council has failed to ensure freedom to provide services in the sphere of international transport [9] and to lay down the conditions under which non-resident carriers may operate transport services in a Member State». However, the effect of this decision was not very far-reaching [10]. After the judgment, the Commission published a white paper with new proposals to achieve the liberalization of internal markets by 1992. In 1991 the Council finally adopted the first and most important Directive (91/440/EEC [11] on the rail sector [12]). This Directive required Member States to guarantee that railway undertakings could have the status of independent operators behaving in a commercial manner and adapting to market needs. In any case, the Council understood that liberalization needed a balance with the current railway market structure, still composed of [continua ..]

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2. The innovations of the first package: organizational separation, capacity allocation and independent regulation

After the ENS and GVG cases, in order to achieve complete market opening in 2010, the first package was approved. Directive 2001/12/EC [23] prescribed a more intense separation between network managers and transport operators. With respect to Directive 91/440/EEC the new act strengthens the separation by introducing a new obligation for organizational division between network managers and transport companies. The first package Directive emended article 6 imposing a separation that is more or less the same as Directive 91/440/EC with the new obligation to keep separate balance sheets and disclose all accounts in detail. The most important innovation was provided in the second paragraph of the same article where each Member State is given the right to opt for organizational separation within the same entity or the provision of two separate legal entities [24]. In fact, article 1 of the former version considered organizational or institutional separation as an option. While article 1 was completely repealed from Directive 2001/12/EC, the new article 6 prescribed the need to opt for organizational or institutional separation. The Directive also extended the notion of undertaking [25] including two kinds of companies: those providing traction and transport and those providing traction only, whereas the former version of article three included only those companies whose main business was to provide at the same time traction and rail transport services for goods and/or passengers. Moreover, the notion of infrastructure manager introduced an innovation thanks to the ability to provide separately the functions of the infrastructure manager to different bodies in different parts of the national network. The licensing of rail operators, already subject to Directive 95/18/EC, had an important modification thanks to Directive 2004/13/EC, which introduced a stronger separation. In fact, the new article 3 of the Directive imposed that the body responsible for issuing licenses was prohibited from providing rail transport services itself and should be independent from bodies or companies that provide such services [26]. The new license system imposed the adoption of a uniform procedure in order to guarantee high standards of quality, safety and non-discrimination in access rights. The allocation of railway infrastructure capacity and the levying of charges for the use of railway infrastructure and safety certification were reformed by [continua ..]

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3. The paradox of further railway packages: internal market rules as the legal basis for the harmonization of technical and safety requirements

After the adoption of the first package the European Union lowered its ability to force liberalization measures on Member States and, as mentioned below, the other packages, all based on internal market rules, did not bring any considerable innovation in opening up markets. The only appreciable achievements that can be underlined refer to the harmonization of rules for the allocation of capacity and for safety. Given this framework and the still monopolized market, especially in Germany, France and Italy, the European Commission approved a second package of legal measures in 2004 [29]. The need for a new legislation arose from a concrete and specific situation: the strengthening of new alliances between the Italians, Germans, Dutch and Austrian rail companies, which pursued the objective to operate on international corridors (especially, Corridor V Lisbon – Kyev) [30]. Because of this agreement the Commission established a new deadline (2007 [31]) to achieve complete liberalization of international freight rail transport. Each Member State should have ensured the full right of access to the network by this date. Passenger transport [32] was, instead, still subject to the same limitations contained in the previous package. From this point of view, the new Directive 2004/51/EC suggests (without obligation) setting 2010 as the last deadline to reach passenger transport liberalization [33]: thus, this condition was not accepted by the Council, where the positions of Germany, France, Italy and Austria prevailed. Nevertheless, the new Directives brought new safety and quality standards and more transparency on the capacity allocation and charging schemes in order to attract more private investors. In fact, until 2004, Member States developed their safety rules and standards mainly on national lines, based on national technical and operational concepts [34]. Simultaneously, differences in standards, approach and culture have made it difficult to break through the technical barriers and establish international transport operations [35]. Moreover, the provisions on safety set forth in Directive 2001/14/EC had proved to be insufficient and differences between safety requirements were still present throughout Europe [36]. In conclusion, the second package highlighted the lack of any genuine will for real liberalization from the Member States and only technical and safety measures were approved. The paradox is that [continua ..]

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4. From rationalization to compromise: approval of the fourth railway package

After the third package, the legal framework was very messy and chaotic, thus the European Union started a renationalization process that led to the unification of all Directives in a single legal act: Directive 2012/34/EU [40]. It groups Directive 91/440/EEC, Directive 95/18/EC and Directive 2001/14/EU because amendments were necessary in order to coordinate the framework and to achieve more legal certainty and clarity [41]. The rationalization of the matter was an important instrument to render railway transport efficient and competitive with other modes of transport. The principle of separation between public powers and economic activities is underlined in the Directive in order to ensure that railway undertakings controlled by Member States have independent status: their assets, budgets and accounts should be separate from those of the State. The Directive repeated the need of independence of railway undertakings too. According to article 5 of the Directive, they must carry out their activities by market rules and manage those activities under the responsibility of their management bodies [42]. In other words, they are asked to behave according to the principles which apply to commercial companies, irrespective of their ownership. Accordingly, the Directive deals with the real separation between the provision of transport services and the operation of infrastructure. According to the Council and the Parliament, in order to ensure fair competition and to guarantee full transparency, these two activities should be managed separately and have separate accounts. The goal is to remove any conflict of interest that may arise and protect the confidentiality of commercially sensitive information. The operator of the service facility should not belong to a body or firm which is also active and holds a dominant position at a national level in at least one of the railway transport markets for the carriage of goods or passengers for which the facility is used. However, Directive 2012/34/EU expressly gives signs of a slight decrease in the goal to achieve complete liberalization; indeed, it clearly provides for an interpretation of the separation specifying that «independence should not entail the establishment of a separate legal entity for service facilities». The Directives also valorize the goal of fair competition underlining that the market opening is not an absolute value [43] but it is an instrument to meet the needs [continua ..]

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5. Overview of the fourth railway package

The fourth Railway Package includes four legislative proposals, three reports and three staff working documents. The most important amendment proposal regards the heart of the liberalization process: Directive 2012/34/EU of the European Parliament and of the Council of 21 November 2012 establishing a Single European Railway Area. The modification of this Directive has a huge impact on two specific features: domestic transport and infrastructure manager governance. It is, indeed, well known that the earlier packages brought a certain degree of liberalization only restricted to international services; the fourth package attempts to open all domestic passenger markets through a legal structure comprising: a) free competition for all lines except b) public tenders for public services lines (where free competition cannot guarantee adequate service. Moreover, infrastructure manager governance is one of the most debated features of the rail reform; indeed, the account separation showed the difficulty in reaching that impartial behavior that is required of an essential facility manager. Therefore, the European Commission provides for the obligation to have institutional separation between the infrastructure manager and the transport operator; however, in the case of a vertically integrated holding structure, each Member State is entitled to introduce some informational barriers, which prevent discrimination in favor of the controlled company. Secondly, there is a specific proposal regarding public transport services through amendments to Regulation (EC) No 1370/2007 of the European Parliament and of the Council of 23 October 2007 on public passenger transport services by rail and by road [48]. This proposal encompasses common rules on the award of public service contracts for passenger transport by rail, together with accompanying measures to increase the success of competitive tendering procedures. The objective of mandatory competitive tendering for public service contracts is to intensify competitive pressure on domestic rail markets, in order to increase the quantity and improve the quality of passenger services. The proposal provides a flexible but formalized and transparent procedure for defining public service obligations and the geographical scope of public service contracts, if competent authorities [49] consider that public intervention is necessary to ensure a politically desirable level of mobility in the territory under their [continua ..]

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6. Opening up domestic passenger markets and centralization of safety certificates: the innovations of the fourth package

One of the most important features of the fourth railway package is the opening of the national domestic passenger transport [51]. Indeed, these markets are still mostly closed. Only Sweden and the United Kingdom have fully opened up their markets, with Germany, Austria, Italy, Czech Republic and the Netherlands having opened theirs to a limited extent. In order to achieve a higher level of innovation, efficiency and value for money, the Commission proposes to open up domestic passenger railways to new entrants and services from December 2019. In this scenario, companies should be able to offer domestic rail passenger services across the European Union: either by offering competing commercial services or through bidding for public service rail contracts, which will become subject to mandatory tendering. In other words, the ability to limit the opening of domestic passenger markets is restricted to those cases where the economic equilibrium of a public service contract is compromised [52]. Concerning public service obligations, the Commission introduces mandatory tendering of these kinds of contracts effective as of December 2019 [53]. The scope of those contracts and the underlying should be defined in compliance with criteria based on general Treaty principles. The Commission Communication clearly explains that it is necessary to prevent contracts where an excessive geographic scope is stipulated for the purpose of market foreclosure. Thus, the Commission proposes a new definition of maximum contract volume through the identification of a minimum threshold below which contracts may be awarded without a public tender, only if the expected savings of public funds would not exceed the costs of tender. In any case, contracts directly awarded after the adoption of the legislative package should not continue to be effective after 31 December 2022. The proposed amendments require Member States to approve, through their competent authorities, public transport plans and set objectives for public passenger transport policy including general performance patterns for public passenger transport. The aim of adopting such plans is to draft public service contracts in a coherent, integrated and efficient manner, related to a specific geographic area. These plans should be drafted in line with the requirements of urban and regulatory mobility plans. The efficiency created by adopting the plans should entail an amount of savings in subsidies higher than [continua ..]

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7. The 'heart' of the fourth package: the institutional separation between the infrastructure managers and transport operators

The strong criticism against the new market players is the holding structure of national companies: for instance infrastructure managers have sometimes considerably increased track and station access charges for passenger services compared to rates asked of incumbents. Moreover, information asymmetries lead to competitive advantages for private operators and there is a steady risk of cross-subsidiarization due to the lack of complete financial transparency. According to the European Commission, the separation requirements prescribed by current legislation met difficulty in being transposed and enforced [60]. Indeed, several infringement proceedings are pending before the Court of Justice because current national legal frameworks are insufficient to remove risks of conflicts of interest and possible distortions of competition. Moreover, if many rail operators presented studies to prove the inefficiency of separation and that integrated rail companies can achieve significant growth in the market, the Commission affirmed that «this must be balanced against strong concerns that rail companies with dominant positions protected by integrated structures in their “home” market could obtain financial benefits giving them an unfair competitive advantage when competing elsewhere in the EU or even domestically against new market entrants». Given this background, the Commission tries to understand if separation is still an efficient instrument to fully develop European railways. Reading the reasoning of the European Commission one can clearly see the reluctance, or better, the renouncement in pursuing complete separation between the infrastructure manager and railway undertakings; indeed, notwithstanding the critical situation described, the European Authority encourages infrastructure managers and service companies to realize appropriate forms of cooperation using a particular route so that proper governance structures can ensure alignment of interests of an increasing number of players in an open market. The paradox of the fourth package is easily seen: insufficient liberalization, caused by the lack of separation and by information asymmetries, should be achieved through cooperation between those entities that should be separated. The political impossibility to reach complete liberalization has been admitted by the Commission, whose proposals for institutional separation of infrastructure management and transport operation was [continua ..]

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8. Conclusion: Chinese walls as a compromise between institutional separation and holding companies

Although the new proposal specifically requires institutional separation between network companies and transport services, in the last paragraph, it provides for an exception related to those cases where the infrastructure manager belongs to a vertically integrated undertaking. In such cases, Member States must ensure that the infrastructure manager performs all its functions through effective organizational and decision-making independence from any railway undertaking. As anticipated, the resolution of conflict of interests [67] through the introduction of Chinese Walls already failed in the financial sector where the Gramm-Leach-Bliley Act of 1999 [68] is considered one of the factors responsible for the Lehman Brothers insolvency [69]. According to Norman [70], it is can be held that information barriers are only a formality to hide the impossibility to achieve real separation. However, the European Commission, which candidly states the political impossibility to prevent the holding structures of railway undertakings, tried to check the real conflicts of interests prescribing three kinds of Information barriers related to: the independence of the infrastructure manager, independence of the staff and management and the provision of a detailed regulation procedure oversee compliance. The first Chinese wall provided by the proposal is the formal separation of the entities within a same holding. The need to achieve effective independence of the infrastructure manager within a vertically integrated undertaking requires Member States to organize the network company as a legally distinct body from any railway holding company controlling such companies and from any other legal entities within a vertically integrated undertaking. However, the mere formal division is not sufficient [71]: consequently the Commission proposes to forbid legal shareholdings from crossing over within the same holding controlling both the network manager and the transport operator. Cross-subsidiarization is equally prohibited: infrastructure manager incomes cannot be used for the financing of other legal entities within the vertically integrated undertaking. These gains are only allowed to finance the business of the infrastructure manager and to pay dividends to the owner. The same principle is applied to the possibility to transfer receivable assets from the network body to the rail operator and vice versa: the infrastructure manager is not [continua ..]

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NOTE

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