Public Private Partnerships (PPPs) and the railways - a new global approach

26 June 2024

Written by Howard Rosen, Article No. 120 [UNCTAD Transport and Trade Facilitation Newsletter N°102 - Second Quarter 2024]

Default image copyright and description

© Adobe Stock

The Luxembourg Rail Protocol to the Cape Town Convention is a game changer, supporting private investment in the railways as part of a PPP strategy, and facilitating environmentally and financially sustainable economic development.

It is universally accepted that governments need to be involved in the building or rehabilitation of strategic infrastructure such as the railways. These are long-term projects that often carry significant financial, political, and even geological risks. But simply because governments build roads, this does not mean that they finance every car that runs along them. Why is it different for the railways? The answer is "legacy" – and this is no longer an acceptable response.

Railways are essential for sustainable economic development

In most parts of the world, the railways have always been state-owned, and therefore rolling stock too has been procured with state funding. But there is an increasingly urgent need to expand and improve rail networks for both freight and passenger transport. Insufficient investment in rolling stock means that expensive rail infrastructure is underused, and both passengers and goods are still predominantly moved around countries by road, which pollutes the environment, gridlocks cities, and kills, and injures millions of people across the world. According to a recent report from the World Health Organisation[1], 1.19 million people die, with 20 to 50 million suffering non-fatal injuries from road traffic accidents alone and in most countries, this costs the economy about 3% of their gross domestic product.

We know that railways are a critical component of economic development and regional integration (and unlike roads they are climate-friendly and sustainable). There is also growing recognition that “open access” (allowing more than one operator to provide services on a particular rail route) is the key to creating a long-term, competitive, and effective rail system. The problem is that government budgets are heavily constrained, and the amounts needed are significant. For example, according to a recent UN Economic Commission for Africa study, about 170,000 new freight wagons alone, costing about USD 36 billion, are required by 2030 to realize the infrastructure planned for the African Continental Free Trade Area[2]

Governments cannot afford to fund sufficient rolling stock

Many governments cannot afford to carry the debt for rolling stock, which can amount to between 20% and 30% of the cost of a new rail project, restricting the services its rail operator can offer. In the future, with new technology, this proportion will increase. Governments may even have to reduce infrastructure investment in order to cover the costs of the rolling stock. But the participation of private operators, whether as part of a franchise, concession, or open access strategy, is significantly restricted because of the (current) heavy capital requirements on them to fund this equipment.

The optimum solution is for the private sector to step in and provide the finance for the railway equipment, without any direct or indirect state guarantees, and secured on the assets being financed.

If the private sector takes on the costs and the risks of financing the rolling stock, it can form the basis of highly effective PPP structures with the added benefit of using operating leases of rolling stock to create more flexibility for operators. This will open the way for more investment in the rail sector, which is particularly important in developing economies. It will also facilitate entry into the market of privately owned, dynamic new operators – even with limited capital.

What has held back private financing?

The challenge, until now, has been to create sufficient security for private sector lenders secured on, and lessors of, railway rolling stock, if there is no government guarantee for the financing (and sometimes even if there is). Currently these creditors face a plethora of risks in asset-based financing structures. These include:

  • The absence in many states of laws protecting creditors on debtor default or insolvency
  • The lack of any public title or security interest registry
  • Unreliable and non-permanent identifiers of rolling stock, in turn undermining creditors’ title claims, with real exposures to theft and fraud, and making real-time tracking of the location of assets almost impossible
  • Conflict of laws and cross-border risks if the rolling stock moves between jurisdictions

These risks mean that creditors either charge a significant risk premium, or just refuse to enter the market. And with trillions of dollars of bank and institutional resources looking for solid and sustainable projects to invest in, this is a huge, missed opportunity.

The Luxembourg Rail Protocol offers the solution

Since early 2024, however, there has finally been a solution in place that addresses these risks and should thus provide a major stimulus for private capital to support the costs of railway rolling stock. This is the Luxembourg Rail Protocol[3] to the Cape Town Convention[4], which is promoted by the International Institute for the Unification of Private Law (UNIDROIT), the intergovernmental organisation that is initiator and sponsor of this global treaty.

The Protocol delivers a new way to attract private capital into the rail sector, making it cheaper and easier for private funders to finance rolling stock without the need for state or multi-state loans or guarantees. It does this by creating a clear global framework for recognising and protecting the rights and interests of secured lenders and lessors financing railway rolling stock, which will be registered in a new international registry[5] based in Luxembourg, accessible to everyone over the internet 24/7. It applies to all rolling stock[6], regardless of gauge, its place of operation or manufacture, or whether it is used or new.

Pioneering unique vehicle identification

For the first time ever, the Protocol also introduces a global unique vehicle identification system (URVIS) for railway rolling stock. The unique vehicle identification number issued by the international registry will be permanently fixed to the rolling stock in accordance with the 2023 UN Model Rules on permanent identification of railway rolling stock[7].

Lower risks lead to reduced costs

The result will be significantly reduced creditors’ risks, costs of funds, and transaction costs, leading to the realisation of cost savings for new and used rolling stock financing. In addition, Export Credit Agencies are being pressed to apply the so called “Cape Town Discount” to risk premiums on supported rolling stock financings, in the same way that they do for aircraft under the Aircraft Sector Understanding[8] when the Aircraft Protocol to the Cape Town Convention applies (in force since 2006). The premium discount for aircraft is 10%; for rolling stock it should be higher, bearing in mind the comparative environmental and development benefits.[9]  

Global support already up and rolling

The Luxembourg Protocol entered into force in contracting states on 8th March 2024. The European Union (in respect of its competences), Gabon, Luxembourg, Spain, and Sweden have already adopted the Protocol, and Paraguay and South Africa are about to ratify. France, Germany, Italy, Mozambique, Switzerland, and the UK have already signed the Protocol, and many other states, including China, Eswatini, Ethiopia, Finland, Kenya, Malta, Mauritius, Namibia, Senegal, and Ukraine are looking at adopting it. The Protocol is endorsed by many international rail organisations (including the Intergovernmental Organisation for International Carriage by Rail (OTIF) Comité international des transports ferroviaires (CIT), and Union Internationale des Chemin de Fer/the Union of International Railways (UIC)) and actively supported by the African Union, the UN Economic Commission for Africa, and the UN Economic Commission for Europe. In September 2023, African transport ministers meeting in Zanzibar adopted a resolution urging all AU (African Union) member states that have not already ratified the Protocol to do so as quickly as possible.

Valuable opportunities and benefits

Even where the Protocol is not yet in force, it creates new opportunities and security for private sector creditors, for example for financing through Special Purpose Companies (SPCs)[10] in contracting states. Since the URVIS numbering system is available worldwide, it will support real-time tracking of the location and utilisation of rolling stock, as well as predictive maintenance programmes, more efficient insurance, and better regulatory supervision.

Now is the time for governments to act

As of today, 86 states have already adopted the Cape Town Convention[11] and 83 have adopted the protocol applying the Convention to aircraft[12]. There is no cost to government to adopt the Luxembourg Rail Protocol. With the urgent need to revive and expand urban and inter-urban rail networks around the world, constrained only by the lack of resources, now is the time for governments to move forward with the adoption of the Luxembourg Rail Protocol to the Cape Town Convention, building it into their strategy for financially sustainable PPP rail projects, helping to release much needed private credit for rail operators, and advancing the fight against climate change.

[1] Global status report on road safety 2023, World Health Organisation, December 2023. The report states that nine in 10 deaths occur in low- and middle-income countries with the risk of death 3 times higher than in high-income countries. By contrast, fatalities and injuries on the railways are a very small fraction of this number. In the EU for example fatalities on the railways represent about 4% of fatalities on the roads and this percentage will be lower in low- and middle-income countries.

[2] https://repository.uneca.org/handle/10855/47596 , specifically 132,857 bulk wagons and 36,482 container wagons and this does not include the significant additional expenditure required for locomotives to move the new wagons, estimated at USD 20 billion by the Rail Working Group, or the cost for specialist freight wagons.

[3] https://www.railworkinggroup.org/wp-content/uploads/docs/railprotocol.pdf

[4] https://www.unidroit.org/english/conventions/mobile-equipment/mobile-equipment.pdf

[5] https://www.rollingstockregistry.com/

[6] Defined as “..vehicles movable on a fixed railway track or directly on, above or below a guide way” (article I (2) (e) of the Protocol) so it applies to trams, light rail and metro trains as well as to all locomotives and passenger and freight wagons.

[7] https://unece.org/sites/default/files/2024-01/ECE-TRANS-337-Rev.1.pdf; with the accompanying guidance notes at https://unece.org/sites/default/files/2023-08/ECE-TRANS-NONE-2023-3efr_with cover page_2.pdf

[8] See https://www.oecd.org/trade/topics/export-credits/arrangement-and-sector-understandings/.

[9] See https://www.railworkinggroup.org/wp-content/uploads/docs/R1034.pdf

[10] Special purpose companies where the debtor would have its principal place of business in a contracting state and would then lease the rolling stock to an operating affiliate. This then creates an international interest under the Protocol which may be registered in the international registry

[11] https://www.unidroit.org/instruments/security-interests/cape-town-convention/states-parties/

[12] https://www.unidroit.org/instruments/security-interests/aircraft-protocol/states-parties/


Disclaimer
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of the United Nations Secretariat.
This site may contain advice, opinions and statements of various information providers. The United Nations does not represent or endorse the accuracy or reliability of any advice, opinion, statement or other information provided by any information provider, any User of this Site or any other person or entity. Reliance upon any such advice, opinion, statement, or other information shall also be at the User's own risk. Neither the United Nations nor its affiliates, nor any of their respective agents, employees, information providers or content providers, shall be liable to any User or anyone else for any inaccuracy, error, omission, interruption, deletion, defect, alteration of or use of any content herein, or for its timeliness or completeness, nor shall they be liable for any failure of performance, computer virus or communication line failure, regardless of cause, or for any damages resulting therefrom.