Network Rail loses £982 million on derivatives

I have pointed out in past years that Network Rail, our nationalised railway industry, is very good at reporting large losses on trading and owning derivatives. Yesterday I looked at charities close to the state and in receipt of large grants that have made a financial success out of it. Today I want to start a review of a nationalised business that receives far larger sums from the state and has made large losses out of it.

The Network Rail management claim they need to deal in derivatives, as they have substantial long term borrowings where the interest rate might go up when they need to refinance. Worse still the company has borrowed considerable amounts in foreign currencies, meaning they have a foreign exchange risk which would require them to pay back a larger sum if the pound falls whilst they owe the debt. They call what they do hedging.

Their latest annual account for 2014-15 states ” Some derivatives do not qualify for hedge accounting and are therefore classified as held for trading. Changes in the fair value of derivative financial instruments that do not qualify for cash flow hedge accounting are recognised in the Income statement as they arise.” This is a complex way of saying that although they claim all their derivatives are needed against borrowings they have made, accountants regard some of them as trading activities. When these go down in value they have to declare the loss each year as it occurs and put up more collateral – more cash – against the position they are running. Last year they needed to find an extra £690 million of cash to sustain their derivatives. The reported loss on derivatives was £982 million.
Is this what a nationalised.l railway should be doing with taxpayers money? Is this Jeremy Corbyn’s dream way to run a nationalised railway? I don’t think they should be borrowing in foreign currencies in the first place, and am glad they are now treated as a business owned for taxpayers by the Department of Transport, using the Treasury to borrow money for them in sterling. Their revenue is in pounds so it is better their debts are in pounds.

When we are trying to control public spending it does not help when a large taxpayer owned business has such an expensive position in derivatives.

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46 Comments

  1. Javelin
    Posted August 23, 2015 at 5:36 am | Permalink

    Can you be more specific John

    Sounds like a Forward Rate Agreement being used to hedge against interest rate changes and an FX Swap (or something similar) for FX changes.

    Now you say a “loss”. I don’t quite understand. They tried to fix the forward fx and interest rates to ensure not making a loss. Surely that is good for the business having certainty. The fact UK interest and FX rates stayed put or moved isn’t really a loss.

    Or are your saying there was truly a loss ? Or that companies shouldn’t try and fix forward rates?

    Reply They have reported a loss and had to find £690 million of additional collateral. I have reproduced what they tell us in their accounts. I don’t think they should borrow in foreign currencies or trade in derivatives

    • James Sutherland
      Posted August 23, 2015 at 5:41 pm | Permalink

      I can see a justification for limited borrowing or trading in foreign currencies, as a lot of businesses do to protect against exchange rate shifts – for example, if they were to buy a billion Euro signalling system from Siemens for delivery and payment in three years’ time, buying a suitable derivative now would protect them against any major appreciation in the Euro’s value during those three years.

      Now, even done sensibly, that could result in a paper “loss”: they might reach 2018 and find the Euro has actually fallen, but they are committed at 2015 exchange rates.

      With losses on this scale, though, I agree they seem to be going far beyond this sort of sensible precaution and simply “playing the markets” – rather badly, trying to play Gordon Gecko with public money but ending up more Nick Leeson! (In fact, his losses peaked at £827m, *less* than Network Rail’s, though that was a few years ago now.)

  2. Lifelogic
    Posted August 23, 2015 at 6:30 am | Permalink

    Should arms of government really be doing any of this “hedging”. It reminds me of all the money lost by local authorities chasing a tiny bit more interest on deposits in the dodgy banks of Iceland.

    Perhaps the treasury should keep all the money (from all state organisations and quangos) until it is actual spent and the treasury should average out and take all the risk.

    Insurance and hedging are nearly always a net loss making activity. You pay in and other take out, but after overheads, profits and commissions rather more goes in than every comes out.
    The treasury should on average therefore be up on the deal. Furthermore all the people at Network rail, the accountants and the others involved in hedging and deposits could be released to get a productive job instead.

    But then I forgot, these types of organisation are usually nearly always run for the benefit of the over paid senior staff.

    • Gary
      Posted August 23, 2015 at 9:55 am | Permalink

      All companies are forced to become hedge traders when rates are rigged. It is an occupation that that are I’ll equipped for , at best it diverts their attention and resources, at worst they lose gobs of money gambling. These unintended consequences are also illustrated by it being cheaper to borrow , buyback the company stock and cash out in options than it is to grow the business.

      The govt and their agencies don’t have a clue what you they are doing and the implications of their policies.

      • Anonymous
        Posted August 23, 2015 at 12:35 pm | Permalink

        Gary – Thanks for that illuminating comment.

      • Anonymous
        Posted August 23, 2015 at 1:27 pm | Permalink

        Gary – Further… we’re talking about a government which struggles with the difference between debt and deficit, gross and net, NEET and unemployed with nearly a million youth out of work and our unofficial school leaving age now 21. Yet they still import unskilled workers by the hnndreds of thousands – costing us billions in wasted money and opportunity too !

  3. Leslie Singleton
    Posted August 23, 2015 at 6:31 am | Permalink

    I hope I am not alone in struggling to understand what on earth they do with the foreign currency Presumably they sell it in to sterling (thence a currency position) and presumably they do not cover forward because that would bring the rate back to sterling. That apart, sterling interest rates are extremely low so puzzlement is complete. As for trading, that could be good fun. Are they buying and selling , even writing, call and put options or persuading themselves they should be doing swaps of some kind, or maybe it’s spread betting.

    • Leslie Singleton
      Posted August 23, 2015 at 7:00 am | Permalink

      Postscript–Lifelogic tells us what this reminds him of (but extra credit exposure in return for a benefit to income is not necessarily bad). What it reminds me of is people a couple decades ago buying houses (ie very significant amounts) via Swiss Franc mortgages, Interesting that the talk was always about the borrowing and never about the currency position caused not by the borrowing (interest apart) but by the selling of the Swiss Francs.

  4. David Cockburn
    Posted August 23, 2015 at 6:44 am | Permalink

    It does sound a bit as though Network Rail is no more competent at managing money than they are at running a railway. Maybe they should focus on trying to get good at railways.
    I should have thought that it would be the role of the Treasury to manage all taxpayer money centrally, balancing off the different currency risks against each other.

  5. alan jutson
    Posted August 23, 2015 at 7:13 am | Permalink

    Simply amazed.

    Given that this is a supposed Nationalised Business, responsible I guess directly to someone (a Minister perhaps) in the Government, who in the Government was responsible for overseeing management, performance, and for the signing off of such deals in the first place.

    If an industry or organisation is Nationalised, surely that means they should get all funding from the Government (taxpayer) direct, why the need to go to the open market at all, why the need to hedge anything, least of all a foreign currency risk.

    Lets face it John, in the rush to privatise the railway we have ended up with a complete shambles.
    Franchises bid to run the routes, recruit staff and buy their own trains, but it would appear the Government also buys trains as well. WHY ?
    In addition some franchises seem to get some funding back from the government for some routes, for some reason WHY ?

    Lots of different time tables, a complicated fare structure with huge range of ticket prices for the same Journey, which can sometimes involve many different operators/franchises.

    Yes the trains are carrying more people than ever, but then that is not difficult or surprising given the shortage of capacity on our roads (little investment made) and the shortage and cost of Parking in our Towns and Cities.

    Heads should roll, without compensation !

  6. Antisthenes
    Posted August 23, 2015 at 7:15 am | Permalink

    Network rail is a monopoly and and receives taxpayers subsidies so there is no incentive for it to work efficiently. Unlike Housing associations that was the subject of your previous article it has not adopted private sector practices and has a public sector mind set.

    Public sector practices are governed by the fact that there is no need to make a profit and making a loss is not a concern because public sector businesses are not allowed to go bankrupt and they know it.

    Demanding better performance from the public sector is not going to achieve much. Although some improvements will be made it will never reach the level of expectation or required. Corbyn is so very wrong when he demands greater public ownership as evidence tells us that leads to incompetence, inefficiency, low productivity and waste. It also leads to reduced wealth creation and impoverishment of the population.

    Network rail will only work better if privatised (difficult to do I admit because of it’s unique situation but possible all the same) and this goes for other public bodies such as the NHS. Privatisation will bring in the need to work efficiently and cost effectively and give the customers the general public and taxpayers value for money.

  7. daveM
    Posted August 23, 2015 at 7:23 am | Permalink

    I’m quite amazed that a company which is in receipt of huge sums of public money is acting like a big-time speculator when its job is to look after railways. Surely that equates to some form of embezzlement when it’s done without taxpayers’ permission??!!

    On a similar subject – I have read this morning that the BBC is to terminate the Met Office’s contract. Any comment on that Mr R? I presume it’s EU tender laws causing this to happen? Maybe the BBC could hire in that Dutch company that doesn’t pay the forecasters who get it wrong!

  8. Richard1
    Posted August 23, 2015 at 7:34 am | Permalink

    Absurd. This sort of thing happens because in the state sector there is no market price for capital – the cost of capital for the managers of a nationalised industry is zero in their eyes: whatever they can cajole the govt to giving them. Network Rail should be returned to the private sector.managers can then be properly held to account for such incompetence.

  9. nigel
    Posted August 23, 2015 at 7:49 am | Permalink

    I am not clear as to whom Network Rail reports? If they are effectively owned by the Government do they report to the Department for transport?
    They seem to have a “board” of highly paid individuals, but we never hear of any repercussions when things go wrong.

    Can anyone clarify this?

  10. agricola
    Posted August 23, 2015 at 7:50 am | Permalink

    I spent thirty plus years in international trading. Almost all of it sourcing automotive components for companies in the UK and USA.

    I took a very simplistic view of how to deal with currency exchange risks. I would say to the customer, make a decision as to whether you are in the automotive business or the foreign exchange business. Do not try to be in both. When you place the order buy the currency forward on the same day. You then know exactly what the cost will be.

    The question for Network Rail is are you maintaining a railway or running a financial trading house, and how well qualified are you to do either. My question for government and the civil servants at the Department of Transport is what do you think you are doing allowing a nationalised industry, dedicated to railway maintenance, to speculate with vast sums of public money, our taxes, in the financial markets.

  11. formula57
    Posted August 23, 2015 at 8:12 am | Permalink

    Perhaps all that is needed to put matters in good order is for the company to change its name to “Network Financial Speculator and Rail”. That way no-one will be misled about the true nature of its business activities.

    I was suprised when you disclosed some long while ago that Network Rail was borrowing in foreign currencies since it does indeed appear to be opening up unnecessary financial exposures. We can assume Network Rail has no good explanation since it has no good explanation for its many failures but why is whatever arm of government that has responsibility for its supervision not taking action to close down this example of casino capitalism?

  12. JoeSoap
    Posted August 23, 2015 at 8:26 am | Permalink

    Well surely there are 2 issues here:

    Why are they borrowing outside Sterling? Could be they are covering Forex positions on forward orders for eg copper cable they placed in US$? Nothing wrong with this surely, but it shouldn’t be generating a loss, so that is a puzzle.

    Why are they making a loss on interest rate derivatives? Presumably the loss is effectively an extra interest charge, as they have basically bought derivatives in much the same way as someone wanting a 10 year fixed rate mortgage pays more than for a 2 year fixed rate.
    The scary thing here is the additional charge is almost a £billion, which is basically going to banks who themselves are borrowing from the government i.e. effectively from the owner of network rail, at 0.5%! So that billion is lopped off by third party finance on its round trip! An expensive rail ticket!

    • forthurst
      Posted August 23, 2015 at 1:31 pm | Permalink

      “[NR] going to banks who themselves are borrowing from the government i.e. effectively from the owner of network rail, at 0.5%”

      Banks create most of their loan capital themselves apart from reserves (fractional reserve banking). Perhaps the solution is to give NR a banking licence to do likewise, filling their balance sheet with titles to plant and equipment instead of property titles.

  13. Anonymous
    Posted August 23, 2015 at 8:27 am | Permalink

    Network Rail is too big.

    Privatisation resulted in the railways being divided in the wrong way. Regional railways, privatised in blocks (track and trains combined – just as they were created) would have flowed better in terms of operations and finance. And such financial ventures (losses) would have been compartmentalised and limited, if undertaken at all.

    Mrs Thatcher didn’t want any involvement in rail privatisation.

    The similarity with Housing Associations is that both resulted in the opposite of what was intended.

    • Anonymous
      Posted August 23, 2015 at 1:36 pm | Permalink

      Housing Associations… well … the whole rental market.

      One BTL owner with a portfolio of 5 homes = 1 Tory voter with 5 Labour voters (who would have been Tory voters if they’d owned their own houses)

      Whereas 6 home owners (with no BTL owners) = 6 Tory voters.

      The rental industry is bad for the Tory movement. It is killing the stakeholder society.

  14. CHRISTOPHER HOUSTON
    Posted August 23, 2015 at 9:30 am | Permalink

    The double-talk of politics has corrupted what were nevertheless loosely defined terms such as “nationalised”. American industries for example are more state controlled if not technically nationalised than any other nation. Even American citizens are “nationalised” in that if they dare go work and live in another country far away from Mother America they still have to pay her income tax.

    In the spirit of what we at present in the UK think of as “nationalised” , Network Rail as you say JR, should not be empowered to engage in the activities which you outline. Yes in the “Free ” World of commerce it is accepted practice to hedge against uncertainty. However, even such commonplace ensurings of certainties, are best handled by people in the know.Even then we have seen some “knowing” and very competent people in a number of US airlines hedging against an increase in oil and aviation fuel increases, others not. Well the hedging for a rise proved economic suicide and for the other “knowing” experts made them economic gurus. Actually, they just got lucky and their opposites just got unlucky. The US frackers survive because of their hedging but they are running out of time and intense pain may follow.

    The point: “nationalisation” as it is historically known in the UK is not possible. The Financial World is not geared up for it. Perhaps it never was. We ( or the Government ) do not have the blinkered eyes of capitalistic accountants who can shift cash and assets from one bucket to another, re-label them, engage in “aggressive accounting”, call “loss of money” a “write down” and make pretty, very pretty balance sheets per annum and the next day dismiss 10,000 staff and declare bankruptcy. We the nationalised people of the UK are not pips on a virtual reality presentation of what some people in the Financial World call the real world. Computer games, by Network Rail operatives, should be practiced in the privacy of their leisure hours, at home, not at work.

  15. oldtimer
    Posted August 23, 2015 at 9:33 am | Permalink

    The only reason I can think that Network Rail would need foreign currency is to pay for large purchases of foreign made equipment. I am not aware of what those purchase might be. Does anyone know (outside Network Rail)?

    • Bob
      Posted August 23, 2015 at 11:52 am | Permalink

      @oldtimer

      “The only reason I can think that Network Rail would need foreign currency is to pay for large purchases of foreign made equipment. “

      If that were the case they should borrow GBP and then purchase the foreign currency to settle with their overseas suppliers.

      The currency purchases can be made on forward contracts if necessary to match the due dates of payments.

      The loan is then repaid from their revenue which is surely denominated in GBP.
      This method would eliminate exchange risk.
      How’s that for a cunning plan?

    • Anonymous
      Posted August 23, 2015 at 1:46 pm | Permalink

      Most of the infrastructure (pointwork, electrical cabling, rails) is made abroad. Many of the sub-contractors working on big projects are foreign – as is the hired plant and much of the hired expertise.

  16. Bert Young
    Posted August 23, 2015 at 9:38 am | Permalink

    When a nationalised entity attempts to behave like a public company it is asking for trouble .It all comes down to the background and efficiency of management and its delegated operatives ; if the experience and skills are not there it will quickly show in the results . Dealing on a day to day basis with derivatives is a highly speculative business at the best of times – those with the necessary background often make big mistakes .

    I have little faith in the supervisory methods that exist between Government and the spending outlets ; the information flow is deplorable and painfully slow . Equally the follow up that follows any report suffers from the same malaise . Things will never improve until the right skills and methods are in place and I have grave doubts that they can ever be recruited or effectively put in place .

    • Leslie Singleton
      Posted August 23, 2015 at 12:28 pm | Permalink

      Dear Bert–I am no friend of derivatives, believe me, but I must quibble at your saying that they are highly speculative “at the best of times”. Used for their original purpose (which is setting up an equal and opposite position to match a position that would otherwise be uncovered and therefore dangerous) they are wonderful (but need tight control)–this is where “Hedge” Funds, indeed “hedging your bets” came in. The problem arises of course when derivative deals are put in place without any question of offsetting (or indeed anything to offset) purely for speculation. Once again a major aspect of what is wrong is that there is no limit on this speculation, not even apparently for a railway.

  17. Gary
    Posted August 23, 2015 at 9:48 am | Permalink

    No mystery there. Henry Hazlitt explained how monetary inflation(credit in our IOU system) disrupts production, inhibits economic calculation, distorts interest rates, mal-employs workers and resources, and consumes capital.Just as serious as the economic disruption are the social consequences of inflation. It destroys thrift, promotes gambling, disheartens the spirit to work, and breeds social unrest, envy, and crime.

  18. Denis Cooper
    Posted August 23, 2015 at 10:18 am | Permalink

    I could hazard guesses about what has happened, but surely there is at least one Commons select committee which has the power to ask questions and insist on answers?

  19. Miami.mode
    Posted August 23, 2015 at 11:09 am | Permalink

    I can understand Network Rail buying a call derivative on perhaps fuel or steel if they have a lot of rail replacement but if the commodities become cheaper then you simply write off the option with minimal loss.

    What I suspect has happened here is that some smart bottomed banker has persuaded them to get loans in a hard foreign currency such as $US or Sfr as the interest would be lower – the loans may well have been pre-crash. At the same time they would have been urged to take an interest rate swap to avoid paying more if interest rates increased but of course rates went down and the swap is more or less like writing insurance against rates going down – rather like issuing a critical illness policy that will keep paying out. Added to that the £ has fallen against both currencies which only adds to the loss. Where this has happened with small businesses they have sometimes managed to get recompense from the banks.

    A lot of this will stem from Gordon Brown’s efforts to keep NR and PFI debt off the government’s books. Shameful all round and all credit to you JR for highlighting the problem.

  20. Tad Davison
    Posted August 23, 2015 at 11:19 am | Permalink

    To have a fully-informed debate, I’d quite like the fans of nationalised industries to tell us how things would be different under public ownership. One thing’s for sure, we just can’t go on like this.

    Tad Davison

    Cambridge

  21. Mark
    Posted August 23, 2015 at 12:17 pm | Permalink

    I note the following comment in the Financial Report:

    Following the decision to reclassify Network Rail as a public sector body (see page 48) the government decided that, to maximise overall taxpayer value for money, the group would cease to raise debt independently and instead borrow directly from the DfT. The policy applies to both the borrowing required for new investment and refinancing of existing debt.

    The regulatory settlement and DfT loan agreement provide strong security for future income and financing.

    Borrowing

    During the year ended 31 March 2015, Network Rail borrowed £6.45bn from the
    DfT. Part of this new debt was used to pay back existing bonds while the remainder was used to invest in the railway infrastructure. As a result, net debt rose from £32,987m to £37,759m.

    Managing interest and foreign exchange risk
    Network Rail manages its interest and foreign exchange risk by using derivative financial instruments (hedges). This is particularly important for Network Rail because, for example, a one per cent movement in interest rates would cause at least £350m of fluctuation in interest costs.

    The total cost of borrowing is quoted as £1,466m in note 9, so the average interest bill is about 4% of borrowings (hard to be precise when they shift over the year). Note 19 reveals details of the borrowing. Of the £31.6bn commercial borrowing in bonds £5.6bn is in USD, with a further £1bn split between AUD, CAD, CHF, JYY and NOK, leaving £25.1bn in sterling. Some £17.6bn is in index linked sterling bonds at low (even zero) nominal coupon rates (but issue prices aren’t disclosed). The DfT has offered a £30.2bn facility expiring in 2019, the terms of which are unclear, to allow for the portfolio to be refinanced through government borrowing – along with an unlimited guarantee on the debt to 2052 (the last maturity date).

    Thus it would seem that Network Rail is no longer permitted to borrow long term on open markets, but will be adding directly to the national debt as it refinances itself. The derivatives will be duly unwound, with profits and losses crystalised on unwinding.

    • Mark
      Posted August 23, 2015 at 7:51 pm | Permalink
    • Mark
      Posted August 23, 2015 at 9:20 pm | Permalink

      I have been scratching my head a little about some of the financial report. It puzzles me why the FD should think that they have a £350m exposure to a 1% rise in interest rates when their debt of £37.8bn comprises only £0.9bn borrowed on a floating rate basis, give or take the unknown terms of the £6.45bn DfT loan. All the rest of the debt has a fixed coupon, or is sterling index linked (£17.6bn), where the coupon and the principal are geared to (?RPI, like IL gilts) inflation, not interest rates. Of course, if inflation rises that increases the chance that interest rates too will rise, so it is just about possible to argue some linkage – however in the shorter term it is really a bet on when negative real interest rates might end.

      The second thing that alarmed me was the statement

      As long as the hedges are economically effective (ie, that they offset changes in the cost of existing and/or future loans), their value at any point in time should not be a key focus when assessing the group’s performance.

      (added bold)

      To my mind that is forward speculation, not hedging – and if the FD has believed wrongly that interest rates would rise because of the shape of the forward yield curve, he will have been consistently proved wrong by ongoing ZIRP. There is nothing to hedge until a loan is taken out and its terms are known.

    • Mark
      Posted August 23, 2015 at 10:38 pm | Permalink

      Some further digging through Note 20 (p114/5) offers perhaps an explanation of where the loss has arisen. The presentation is a little odd and obfuscatory, being spread over 2 pages instead of listing the status in 2014 and 2015 side by side. Individual derivatives that are in profit are grouped together as fair value assets, while exactly similar derivatives that are in loss are grouped as fair value liabilities. Therefore, to see the movements between the years it is necessary to calculate the net fair value profit or loss in each derivative category.

      The biggest item is “Forward start interest rate swaps”, which in 2014 were £11,519m plus £5,835m, or £17,354m notional principal (effectively an approximation of the amount of debt “hedged”), with a mark to market profit of £308m-£59m or £249m. In 2015 these were £13,282m of notional principal, with a mark to market loss of £779m, for a total mark to market loss over the period of £1,028m – more than the net overall total across all categories. It looks like I smelled the right rat.

      I think it has to be said that the whole financial edifice is probably driven by the ORR’s regulatory regime that allows for some inflation and otherwise a nominal return on the “regulatory asset base”. It might be wrong to lay the blame solely with Network Rail management. Now that it is formally nationalised, there are perhaps even more questions to be asked about how it will be effectively monitored, and the role of the ORR.

    • Miami.mode
      Posted August 24, 2015 at 6:15 am | Permalink

      Well researched Mark and it looks as though JR may not have to write on this subject next year.

      George Osborne may have missed a trick when he first came into office by not coming clean then, new CEO and kitchen sink etc.

      • Mark
        Posted August 24, 2015 at 11:52 am | Permalink

        I fear he will have to write about Network Rail now that it is nationalised – as I point out above, it will be difficult to ensure it gets proper scrutiny. That’s even before we start looking at ideas such as converting rail tracks to commuter HOV lanes or dedicated freightways for automated vehicles in future, which are unlikely to be considered by a nationalised industry monolith.

  22. Francis Lankester
    Posted August 23, 2015 at 12:20 pm | Permalink

    When did they start doing this? Does anyone know?

  23. Grumpy Goat
    Posted August 23, 2015 at 12:56 pm | Permalink

    Sad but as one previous commented is there not a minister in charge of the nationalised railway. Does not buck stop there? NR should be sold off as soon as possible. Under treasury control it come under the CSR, as transport is not protected god help the railways. Any private solution should learn from the mistakes of Railtrack , which was a disaster, people died due to their incompetence.

    • Mark
      Posted August 23, 2015 at 7:50 pm | Permalink

      The Secretary of State for Transport is now the “sole member” of Network Rail. It’s fully nationalised.

  24. forthurst
    Posted August 23, 2015 at 1:24 pm | Permalink

    I looked at the accounts last time JR raised this issue and noted the extraordinary collection of loans and derivatives. It would be interesting to find out just how much of Network Rail’s new plant and equipment is either manufactured overseas or by foreign owned businesses here, probably most of it; we have come a long way since the opening of the Liverpool and Manchester Railway in 1830 and not in a good direction, largely as a consequence of nationalisation, starving BR of funds for capex in order to prioritise social expenditure, denationalisation, renationalisation, all apart apparently apart from the last stage with oversight by incompetent politicians.

    When NR purchases from abroad, it needs funding to cover the initial ‘investment’ and also during its lifetime, 10-50 years depending on asset class and may need funding to cover the depreciation of the assets if that too is not covered by income. It is quite easy to see how naive businessmen can be led a dance by banksters to whom they are ever more in hoc as the burgeoning asset class is balanced by burgeoning liabilities owed to banksters or even how they can become so enthused by the complexity of the arrangements but together to rip them off that they even delude themselves into thinking they would like to make money that way themselves. In the bad old days, the man in charge of the money was called the Company Secretary and did not hold a directorship; as he would not be able to defend himself at board meetings, he wisely chose a conservative and modest approach to his role. Perhaps a new companies act is due in which this old arrangement is mandated retrospectively to stop accountants deluding themselves that they can run businesses or improve its prospects by financial chicanery.

  25. Rods
    Posted August 23, 2015 at 3:22 pm | Permalink

    Hedging using derivatives can be a useful tool for managing risk when you have fixed priced contracts and they are used for guaranteeing a currency exchange rate when buying materials from abroad or hedging against other other volatile expenses. If this was the case then I would expect only the quantifiable costs of the derivatives to be in the accounts and the only losses are when the derivative is not exercised. This is a perfectly reasonable business practice, but I don’t think this is what we are talking about here.

    The other side of a derivative contract is when you are using your assets as the tradable item and it is used by many financial institutions to increase their earnings. If market conditions mean that it makes no sense to exercise the derivative then you make a profit from what you were paid for risking those assets but if it is exercised it is only at this point that the downside losses become quantifiable and they can be many, many, many, times the potential profit.

    I can only assume it is the later that Network Rail are doing and doing it very badly! IMO as they are not a financial institution, they are not only not going to have the savvy to do this profitably, but they are also not going to have the instantaneous trading systems to minimise the losses.

    Is taking these risks with taxpayers money a reasonable thing to do? No.

    Should they be doing them? No.

    It is good that you have highlighted this, but it raises two further questions?

    Are the civil servants that are sanctioning and operating this going to be surcharged so the bill ends up where it belongs, with them and not with us taxpayers?

    As an MP and a member of the Government what are you going to do to stop the wasting of our hard earned taxpayers money in such an inappropriate way.

    • JoeSoap
      Posted August 23, 2015 at 6:12 pm | Permalink

      Good post.
      Over to you, host.
      For at least 2 years you have highlighted this. As taxpayers and rail passengers, we are owed a proper explanation please. This is not a private or quoted business playing fast and loose with shareholders’ money-it is civil servants playing with taxpayers’ money – OUR money. We should know what is behind this.

    • Miami.mode
      Posted August 23, 2015 at 7:37 pm | Permalink

      I agree with you Rods that they seem to be on the wrong side of a derivatives contract.

      Many years ago I had a small Traded Options account with a stockbroker and I only ever used a call option. Nevertheless I still had to sign a form to say that if I ever wrote a put option the broker could demand collateral from me, which included my house, if the market moved against me. Bearing in mind that JR says NR are having to pay more collateral this would appear to confirm the market is moving against them. As interest rates have been stable for some years this would suggest it is a currency problem and will have unlimited liabilities.

      If the BoE increased interest rates with the assumed improvement of the £, NR may get some of their money back.

      • Mark
        Posted August 23, 2015 at 9:28 pm | Permalink

        At least with a put option your loss would have been bounded by the strike price. If you had written calls, the sky could have been the limit. Option writing is for the brave, as it really depends on mispricing by buyers who over-estimate likely price volatility.

        • Miami.mode
          Posted August 24, 2015 at 6:45 pm | Permalink

          Sorry Mark I should have said writing all options rather than just puts.

  26. Lindsay McDougall
    Posted August 24, 2015 at 2:21 pm | Permalink

    If a nationalised “business” makes repeated and substantial losses, then it isn’t a business, it’s a bunch of parasites. Network Rail is the nationalised Railtrack. While John Major’s privatisation of the railways was not the best system, it did rely on Railtrack being able to charge market rates for track access charges. Stephen Byers insisted on Railtrack reducing these, rendering it uneconomic. The practical outcome was that Railtrack first skimped on track maintenance, then hit the panic button, then collapsed into insolvency.

    If we can’t think of a better form of railway privatisation, then Network Rail should be re-privatised. Myself, I favour vertically integrated private sector regional companies. Competition would come from car, bus, tram, air, road haulage and short sea shipping/pipelines. If an element of competition within the railway system were needed, then the regional companies could be obliged to allocate 10% of train paths to independent operators (a bit like guest beers in pubs).

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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