Guidance on the Application of Regulation 1370/2007 on Passenger Transport Services

train entering station
Public service obligations may only be imposed where the market does not provide adequate services in terms of price and/or quality. The selection of service providers must respect the principles of openness, transparency and non-discrimination, even when public procurement procedures may not apply. Compensation must be based on contracts which contain a precise definition of the public service and parameters on how the compensation is to be calculated. Changes in the conditions of a public service after a contract is awarded are likely to require a new procurement procedure. Costs and revenues must be allocated between eligible and non-eligible activities, according to an established methodology. Reasonable profit should be the internal rate of return of the service provider. Efficiency requirements should be imposed so as to incentivize the service provider.

Introduction
 
The European Commission published last week a Communication that explained its own understanding of how Regulation 1370/2007 had to be implemented.[1] The Communication does not have the status of a Guideline as other Guidelines on State aid compatibility which express Commission policy. This is because the Regulation has been issued by the European Parliament and the Council. 

Nevertheless, the Communication offers valuable guidance. The Communication refers to concepts which are specific to the Regulation and do not apply to sectors other than transport. But the Communication also deals with issues that have wider State aid application and relevance.

This article focuses on those broader issues and draws lessons that are useful to other areas of State aid, especially where public authorities impose public service obligations on market operators or define and subsidise services of general economic interest.[2]

Scope of the Regulation

The Regulation excludes from its scope of application measures which fall within the remit of public procurement directives: Directive 2014/24 on public procurement, which will replace Directive 2004/18, Directive 2014/25 on procurement by entities operating in the water, energy, transport and postal services sectors, which will replace Directive 2004/17, and the new Directive 2014/23 on concessions. The new Directives were also published last week and will have to be transposed into national law by April 2016.

The Regulation also makes a distinction between service contracts and service concessions. A service contract is a contract for pecuniary interest for the provision of services. A service concession is a contract for pecuniary interest for the right to exploit services under operating risk. Therefore, the decisive difference is the assumption of commercial risk.

The Communication very usefully provides a table that shows how the Regulation and the Directives apply to contracts and concessions to the various modes of road and rail transport.

 

Public passenger services Rules applicable to
service contracts*
Rules applicable to
service concessions**
– bus & tram Directives 2014/24 & 2014/25

 

Regulation 1370/2007
– rail & metro Regulation 1370/2007

 

Regulation 1370/2007

 

* As defined in Directives 2014/24 & 2014/25.

** As defined in Directive 2014/23

Features of a public service contract

A public service contract consists of one or more legally binding acts confirming the agreement between a public authority and a public service operator. The contract may also consist of a decision adopted by a public authority taking the form of an individual legislative or regulatory act under which the authority itself provides the services or entrusts the provision of such services to an internal operator.

General rules

A question often asked is whether the provision of a service of general economic interest can be covered by general rules. General rules are measures that apply without discrimination to all public service operators of the same type in a given geographical area. General rules are measures that may be imposed unilaterally by public authorities and therefore are usually not negotiated with individual public service operators. For example, a public authority may decide to use general rules to establish social or qualitative standards in accordance with national law. The Communication explains, however, that when general rules involve compensation or an exclusive right, there is an additional obligation to conclude a public service contract.

If the general rules provide for compensation or if the public authority thinks that the implementation of the general rules requires compensation, a public service contract defining the obligations and the parameters of the compensation of their net financial effect will also have to be concluded.

Definition of public service obligations

Member States have wide discretion to define public service obligations in line with the needs of end users. A public service obligation is a requirement to ensure public [passenger transport] services in the general interest that an operator, if it were considering its own commercial interests, would not assume or would not assume to the same extent or under the same conditions without reward. Typically but not exclusively, public service obligations can refer to specific requirements placed on the public service operator as regards, for instance, the frequency of services, service quality, service provision in particular at smaller intermediate stations which may not be commercially attractive, and the provision of early morning and late evening trains. The Commission considers that the services to be classified as public services must be addressed to citizens or be in the interest of society as a whole.

Award of public service contracts

Public authorities may provide public [passenger transport] services themselves or award a public service contract directly to an internal operator. However, if they choose the second option, they must respect a number of strict rules and conditions. An internal operator must be a legally distinct entity over which a public authority exercises control similar to that exercised over its own departments.

If a public authority uses a third party other than an internal operator to provide public services, it must award public service contracts through a fair, open, transparent and non-discriminatory competitive tendering procedure.

Contract award procedures must be designed so as to create conditions for effective competition. The application of the general principles of the Treaty, such as the principles of transparency and non-discrimination, implies, for instance, that the assessment criteria for the selection of offers must be published with the tender documents.

A public authority may also choose to negotiate with the pre-selected parties, after a pre-selection of tenders, in the case of specific or complex requirements. An example of this is when bidding operators must come up with technologically innovative solutions to meet the requirements published in the tender documents.

In order to provide potential tenderers with fair and equal opportunities, the period between the launching of the competitive tendering procedure and the submission of the offers, as well as the period between the launching of the competitive tendering procedure and the moment from which the operation of the services has to start, must be of appropriate and reasonable length.

To make the competitive tendering procedure more transparent, public authorities should provide all the relevant technical and financial data, including information about the allocation of costs and revenues if available, to potential bidders to assist in the preparation of their offers.

Modifications of public service contracts

Where a running public service contract needs to be amended, for instance where the transport service volume and corresponding compensation amount need to be adapted due to an extension of a metro line, the question arises whether the public authority should start a new award procedure or whether the contract can be amended without a new award.

The Court of Justice has held that in the case of minor, non-substantial modifications a new award may not be necessary to ensure that general Treaty principles such as transparency and non-discrimination are complied with and a simple amendment of the contract may be sufficient. According to the Court, in order to ensure transparency of procedures and equal treatment of tenderers, substantial amendments to essential provisions of a service concession contract or to contracts subject to the public procurement directives require the award of a new contract in certain cases. This is the case, in particular, if the new provisions are materially different in character from the original contract and are therefore such as to demonstrate the intention of the parties to renegotiate the essential terms of that contract. According to the Court, an amendment to a contract during its term may be regarded as substantial if it introduces conditions which, if they had been part of the original award procedure, would have allowed for the admission of tenderers other than those originally admitted or would have allowed for the acceptance of an offer other than that originally accepted.

Public service compensation

In order not to constitute State aid, public compensation has to respect the four conditions laid down by the Court of Justice in the Altmark judgment.

In the 2012 SGEI package, the Commission made it clear that selection of service providers on the basis of open procurement procedures conforms to the 4th Altmark criterion. However, a negotiated procedure or a competitive dialogue is not in conformity with that criterion.

Public procurement procedures must be designed in such a way to create conditions for effective competition. A purely negotiated procedure without prior publication of a contract notice is against the principles of transparency and non-discrimination. Similarly, a tender procedure which is designed in such a way as to unduly restrict the number of potential bidders does not comply with those principles.

Selection criteria, including for example quality related, environmental or social criteria should be closely related to the subject-matter of the service provided. The awarding authority is not prevented from setting qualitative standards to be met by all economic operators or from taking qualitative aspects related to the different proposals into account in its award decision.

Absence of overcompensation in the case of directly awarded public service contracts

Compensatory payments must not be higher than the actual net cost for the provision of the public service over the lifetime of a contract. Additionally, the Commission considers that regular checks are in principle needed during the lifetime of the contract in order to detect and avoid at an early stage clear overcompensation situations from developing. This is the case, in particular, for long-term contracts.

Compensation must be limited to the net financial effect of the public service obligation. This is calculated as costs minus revenues generated by the public service operations, minus potential revenues induced by network effects, plus a reasonable profit.

Relevant costs and revenues

On the cost side, all costs directly linked to the provision of the public service can be taken into account [e.g. salaries, maintenance, overhead costs (such as cost of management and administration)]. Where the service provider also carries out activities that fall outside the scope of the public service, an appropriate part of the costs that are shared between public service and other activities [e.g. office rental costs, salaries of accountants or administrative personnel] may also be taken into account on top of the direct costs necessary to discharge the public service. Where the undertaking holds several public service contracts, the common costs must not only be allocated between the public service contracts and other activities, but also between the different public service contracts. To determine the appropriate proportion of common costs to be taken into account in the public service costs, market prices for using the resources, if available, may be taken as a benchmark. If such prices are not available, other methodologies may be used where appropriate.

Please note, however, that the 2012 SGEI Framework does not allow such allocation of common costs. Only the incremental costs of the public service are eligible for compensation.

Revenues directly or indirectly related to the provision of the public service, such as revenues from the sale of tickets or from the sale of food and drinks, must be deducted from the costs for which compensation is claimed. Other benefits from the public service contract must also be taken into account.

Reasonable profit

Reasonable profit means a rate of return on capital that is normal for the sector in a given Member State and that takes account of the risk, or absence of risk, incurred by the public service operator by virtue of public authority intervention.

The Commission Communication on SGEI provides some guidance on the determination of the level of reasonable profit that may serve as an indicator for public authorities when awarding public service contracts. Where generally accepted market remuneration exists for a given service, that market remuneration provides the best benchmark for the compensation in the absence of a tender. Such benchmarks would ideally be found in contracts in the same sector of activity, with similar characteristics and in the same Member State. The reasonable profit must therefore be in line with normal market conditions and should not exceed what is necessary to reflect the level of risk of the service provided.

However, such market benchmarks do not always exist. In that case, the level of reasonable profit could be determined by comparing the profit margin required by a typical well run undertaking active in the same sector to provide the service in question.

A standard way in which to measure the return on capital of a public service contract is to consider the internal rate of return (IRR) that the company makes on its invested capital over the lifetime of the project, that is to say the IRR on the cash flows of the contract. However, accounting measures, such as the return on equity (ROE), the return on capital employed (ROCE) or other generally accepted economic indicators for the return on capital may also be used.

Depending on the particular circumstances of each public service contract, a case-by-case assessment by the public authority is needed to determine the adequate level of reasonable profit. Among other things, it must take into account the specific characteristics of the undertaking in question, the normal market remuneration for similar services and the level of risk involved in each public service contract. For example, a public service contract that includes specific provisions protecting the level of compensation in the case of unforeseen costs is less risky than a public service contract that does not contain such guarantees. All other things being equal, the reasonable profit in the former contract should therefore be lower than in the latter contract.

Preventing cross-subsidisation of commercial activities

When a public service provider also carries out commercial activities, it is necessary to ensure that the public compensation it receives is not used to strengthen its competitive position in its commercial activities. Costs and revenues pertaining to the provision of services under each public service contract must be correctly allocated between activities covered by the contracts and other commercial activities.

The adequacy of the cost-sharing and ring-fencing measures between the public service obligation and other commercial activities are crucial in this respect. For example, when means of transport (such as rail rolling stock or buses) or other assets or services needed to discharge the public service obligation (such as offices, personnel or stations) are shared between public service and commercial activities, the costs of each must be allocated to the two different types of activities in proportion to their relative weight in the overall transport services provided by the transport undertaking.

Once more, please note that the 2012 SGEI Framework has special rules on common cost allocation.

Design of compensation schemes to promote efficiency

Efficiency must be understood as the relation between the quality or level of the public services and the resources used to provide those services. Efficiency incentives should therefore focus on reducing costs and/or increasing the quality or level of service.

Efficiency incentives in the compensation mechanism should be used especially in instances where uncertainty about costs is large and the service provider needs a high degree of protection against that uncertainty, but also the public authority needs to prevent excess profits. By contrast, compensation schemes which simply cover actual costs as they occur provide few incentives for the service company to contain costs or to become more efficient over time.

Efficiency incentives should nevertheless be proportionate and remain within a reasonable level, taking into account the difficulty in attaining the efficiency objectives. This may, for example, be ensured through a balanced sharing of any rewards linked to efficiency gains between the operator, the public authorities and/or the users. In any event, a system must be put in place to ensure that the undertaking is not allowed to retain disproportionate efficiency benefits.

The parameters for compensation should be set in such a way that compensation is appropriate and reflects a desire for efficiency and quality of service. In addition, the parameters of these incentive schemes must be fully and precisely defined in the public service contract.

 


[1] Communication from the European Commission, Interpretative Guidelines Concerning Regulation 1370/2007 on Public Passenger Transport Services by Rail and by Road, OJ C 92, 29 March 2014. The text of the Communication can be accessed here:

http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=OJ:C:2014:092:TOC#C_2014092EN.01000101.doc

[2] Out of necessity, I copy extensively the text of the Communication. Although it is not covered by any copyright, it is appropriate to acknowledge that.

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About

Phedon Nicolaides

Dr. Nicolaides was educated in the United States, the Netherlands and the United Kingdom. He has a PhD in Economics and a PhD in Law. He presently holds positions at the College of Europe and the University of Maastricht. He has published extensively on European integration, competition policy and State aid. He is also on the editorial boards of several journals. Dr. Nicolaides has organised seminars and workshops in many different Member States, and has acted as consultant to several public authorities.

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