Derivative losses at Network Rail – could we spend on the railway instead?

We all know Network Rail needs loads of subsidy to run a railway. What has gone unremarked is how good they are at losing money on buying and holding financial derivatives. In the year to March 2011 Network Rail reported a loss of £251 million on these instruments by marking them to market, and in the year to March 2012 another £93 million. At their last annual balance sheet date they showed total liabilities of £1.2 billion in derivatives, as if they are running their own investment bank.

So what is the case for the defence? They say they are not taking speculative positions. They say they are hedging their currency and interest rate risks.It’s part of their financing. It is difficult to see why a national UK railway company with predominantly sterling revenues and sterling grant paid by the taxpayer should have currency risk problems. They seem to arise mainly because the company has a penchant for borrowing in foreign currencies. It has chosen to borrow in Swiss francs, US dollars, Norwegian krone, yen, Canadian dollars and Australian dollars. It is difficult to know why it needs to tap these more exotic bond markets, when there is a large and fairly reliable sterling bond market which would avoid all the hassle.

The Group has also had a wish to borrow using index linked bonds. This tends to be a dear form of financing given the persistently high inflation rates experienced in this country. They may have lost money on interest rate hedges because interest rates have been low or falling rather than rising. Most longer term borrowers protect themselves against rising interest rates by borrowing at a fixed rate, and borrowing long if rates are low. This apparently is too easy an approach for Network Rail.

So it all means the poor old taxpayer has to pay for the costs of an investment bank type operations as well as the losses on the railway. Surely someone could get a grip on this, and take Network Rail out of the derivatives business?

To sort out Wokingham’s traffic problems and to cut the risks on the railway we need a bridge or underpass in place of a level crossing. That would be small beer besides the costs of these exotic financings and hedges. It would also be a much more popular way of spending the money, if replicated around the country.

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  1. Pete the Bike
    Posted July 17, 2012 at 5:38 am | Permalink

    Eliminate subsidies. All subsidies for any business. They distort the market and you end up with uncompetitive and inefficient lame ducks that will never pay their own way. This is proved by every single industry or sector that the government bails out or runs. If it is worth doing the private sector will do it better, quicker and fairer.

    • lifelogic
      Posted July 17, 2012 at 7:18 am | Permalink

      Indeed a level playing field, no distorting subsidies usually for mad “green religion” reasons and no silly selective tax breaks works best for all.

      • lifelogic
        Posted July 17, 2012 at 10:01 am | Permalink

        It is just making Adam Smith’s invisible hand do great harm by distorting its market signals.

        • Bazman
          Posted July 18, 2012 at 6:02 am | Permalink

          Was not so invisible in banking was it. Maybe needed a bit of direction by regulation? Oh dear. Was it the regulators fault or banking? Now we are in a tizz.

          • Denis Cooper
            Posted July 18, 2012 at 8:39 am | Permalink

            Mervyn King’s fault, of course.

            He’s got a funny name that we all know and he’s plump and bespectacled, and everything is his fault, apparently, at least as I read in the Telegraph.

            While Sir Callum McCarthy, the first chairman of the FSA from September 2003 until October 2008, is being kept out of the frame – why?

          • lifelogic
            Posted July 19, 2012 at 3:36 am | Permalink

            Distorting subsidies that make people do daft things like invest in wind farms and pointless HS2 are one thing.

            Sensible regulation of banking and insurance to makes sure the companies can pay up at the end of the day and prevents cartels and market distortions is quite another. Surely you can see that can’t you?

          • Lindsay McDougall
            Posted July 19, 2012 at 8:02 pm | Permalink

            As I have said many times, RBS and HBOS should have been allowed to fail, with an administrator or a receiver sent in as appropriate according to their levels of debt. The fact that this didn’t happen was because of the actions of Gordon Brown, a Socialist Prime Minister. Capitalism hasn’t failed, it hasn’t been properly tried.

            There is a huge danger of Brown’s folly being copied in Spain, Italy and France. For goodness sake, let failed banks fail and let’s move on. Combine that attitude with a willingness to let fiscally incontinent Member States leave the Euro zone and we would be well on the way to solving Europe’s immediate problems.

    • Greg Tingey
      Posted July 17, 2012 at 7:24 am | Permalink

      Like the health services in the USA until recently you mean?

      • lifelogic
        Posted July 17, 2012 at 10:07 am | Permalink

        Health services in the USA are not perfect, the doctors, insurance companies, over defensive medicine and litigation lawyers get away will distorting the market hugely. Nevertheless it is rather better than the NHS with its results – despite the fact that so many eat far too much rubbish.

        • uanime5
          Posted July 17, 2012 at 9:37 pm | Permalink

          Actually the NHS had higher rates of infant mortality and lower life expectancy than the UK despite the percentage of GDP they spend on healthcare being double what is spent in the UK.

          The main reason the US is so expensive is that these private hospitals inflate their costs to make larger profits.

        • APL
          Posted July 17, 2012 at 9:48 pm | Permalink

          lifelogic: “Health services in the USA are not perfect, ”

          Nor is the US health service a free market. The drug market is distorted to the extent that it is cheaper to buy American drugs from Canada and re-import them to the US.

          The dead hand of big government strikes again.

        • Bazman
          Posted July 18, 2012 at 6:04 am | Permalink

          Millions in the USA have no healthcare or are in poor jobs just to provide healthcare. More fantasy from you.

    • David Price
      Posted July 17, 2012 at 11:51 am | Permalink

      “Better, quicker and fairer” is not a universal truth. I am not aware of any private sector emergency medical services for example.

      However, with the private sector you generally don’t have to pay for a service you don’t use/benefit from, can move your custom to a better provider if the first fails and even punish the management through loss of bonus etc if the shareholders have sufficient sway.

      With regards to subsidies and favouritism for commercial services, other countries are quite happy to do that – US, Germany, France etc? I am not in favour of subsidies in general but how do you suggest our business could compete favourably against such disadvantages given everyone else seems to do it?

      • lifelogic
        Posted July 17, 2012 at 4:32 pm | Permalink

        “Better, quicker and fairer” is not a universal truth. I am not aware of any private sector emergency medical services for example.

        Well of course there is not much in the way of private emergency services in the private sector. Any that tried would be under cut by a “free” at the point of use state one. How could they exist with a “free” tax payer funded subsidised competitor?

        • David Price
          Posted July 17, 2012 at 6:23 pm | Permalink

          I’ve noticed that the scoialists like to invent “truths” and data, call their opponents “liars” if it’s only a mistake or the information is open to interpretation anyway, generalise, stereotype and exagerate.

          If the conservative/ukip/rational argument is to be credible I simply don’t think the socialist form of argument relying on dogma and hysteria should be adopted.

          • David Price
            Posted July 17, 2012 at 6:27 pm | Permalink

            This was not to imply the OP was employing hysteria but the notion of private sector all good and public sector all bad, even though it simply reflects the socialist claptrap aint demonstrably true either.

        • Bazman
          Posted July 18, 2012 at 6:06 am | Permalink

          What if you could not afford an ambulance or your policy did not cover that type of accident. Do tell us and stop hiding from your own stupidity.

          • lifelogic
            Posted July 19, 2012 at 3:39 am | Permalink

            Clearly some provision is needed for those genuinely unable to pay.

      • Martin
        Posted July 17, 2012 at 6:09 pm | Permalink

        I can think of a certain private TV company that forces me to pay for lots of channels I will never watch before it lets me pay for its sports offering. Not much different from a certain nationalised TV company.
        (Just a lot more expensive!)

        • lifelogic
          Posted July 17, 2012 at 7:40 pm | Permalink

          Well do not watch the sport it is boring anyway.

          At least they do not force you to pay just to own a TV as the BBC do and then pump “BBC think” at you.

    • waramess
      Posted July 17, 2012 at 12:40 pm | Permalink

      Amazing discovery. Quite agree, let the railways compete with roads and other forms of transport and let the best man win.

      • lifelogic
        Posted July 17, 2012 at 4:33 pm | Permalink

        let the best van win perhaps.

        • Bazman
          Posted July 18, 2012 at 6:09 am | Permalink

          Loaded with coal? Oh you could use a lorry? How much do you think a 42 tonne lorry can carry in coal. 42 tonne? Wrong!

          • lifelogic
            Posted July 19, 2012 at 3:43 am | Permalink

            Coal is something that can work well by train as it is usually going on the same route from source to power station. Or was until the EU started to kill coal.

    • uanime5
      Posted July 17, 2012 at 9:39 pm | Permalink

      Removing subsidies usually results in the extra costs being passed onto the taxpayer or bankruptcy (no service). Both are problematic if the Government wants more people to use trains so they don’t have to build more roads.

      • Bazman
        Posted July 18, 2012 at 6:12 am | Permalink

        Costs, including financial, externalised onto the user, the taxpayer, the employee and the general public in many cases. With large fees and wages called remuneration given to retards in the right place at the right time.

      • lifelogic
        Posted July 19, 2012 at 3:45 am | Permalink

        Why should the government have a “more by rail” agenda it make no real sense from a green and any other perspective in general.

  2. Mike Stallard
    Posted July 17, 2012 at 5:41 am | Permalink

    Well noticed!
    To most people, remember, the railways are a luxury. But in your constituency they make real everyday impact. To make them succeed you need regular constant stream of passengers or goods traffic and most of us live in places where that just does not happen.

    Allow me to ask. How much of all this is EU?
    They have an integrated transport policy for Europe. they have their own Directorate called DG MOVE whose stated aim is to promote the development and roll-out for integrated transport management systems. They have a Register of Railway Infrastructure covering all sections of line and track with no less than 153 categories of information.(Source “The EU in a nutshell”.)
    It looks to me as if they are in charge, not Network Rail who certainly ought not to be playing with investments.

    • Greg Tingey
      Posted July 17, 2012 at 7:27 am | Permalink

      London has 10 million people in it, 15% of the whole UK’s population, Glasgow has 1 million people, 15-20% of Scotland’s
      Birmingham & Manchester have another 2 million …
      Without railways (in the widest sense), those cities will grind to a halt.
      Railways are emphatically NOT a luxury.
      They are essential.
      And that’s without even thinking about the block container freight trains …..

      • stred
        Posted July 17, 2012 at 9:17 am | Permalink

        Yes. If you live in a dump, you need dump transport. Well spotted.

      • lifelogic
        Posted July 17, 2012 at 10:08 am | Permalink

        What is wrong with the cheaper and far more flexible, intercity coaches?

        • lifelogic
          Posted July 17, 2012 at 10:09 am | Permalink

          More green too in c02 terms all considered.

        • stred
          Posted July 18, 2012 at 2:36 am | Permalink

          They get stuck in congestion because of the ridiculous lack of investment in roads. I gave up on the ‘flyer’ from the south to Stansted, having nearly missed my flight. If the goons invested in roads, we wouldn’t need railways and long distance buses would work.

      • Alan Wheatley
        Posted July 17, 2012 at 10:34 am | Permalink

        Much of the wealth is in the cities. If for them railways are a necessity then they can pay the full cost. And I take it it is not just short-distance commuter trains.

      • David Price
        Posted July 17, 2012 at 11:55 am | Permalink

        Even if they are not a luxury why should those of us who don’t live or work in those cities nor use the railways have to subsidise them?

      • waramess
        Posted July 17, 2012 at 12:42 pm | Permalink

        What’s wrong with alternative forms of transport?

        • lifelogic
          Posted July 17, 2012 at 4:38 pm | Permalink

          The BBC and MPs don’t like them. They would rather read a book in first class (on expenses and with tax payer subsidy too) on a train, with a nice lunch. While imagining, quite erroneously, that they are saving the world.

    • Acorn
      Posted July 17, 2012 at 8:31 am | Permalink

      Mike, Network Rail has ended up being a very strange animal. Is it public sector or private sector? Who or what carries the liability for its £27 billion debt? Probably best if they get rid of the CFO; he seems to buy any old boiler house junk the banksters stick under his nose. NR should phone one of those miss-selling companies that advertise on daytime TV. Then (criticise-ed) the guy who wrote the company articles for NR. What was the ORR Regulator doing all this time? .

      Reply The CFO will probably tell us the derivatives are insurance, and that the total funding cost is acceptable etc.

      • waramess
        Posted July 17, 2012 at 12:46 pm | Permalink

        No doubt that he would be fired if he were a public company. Getting the interest rate forceast so very wrong and commiting such vast sums to the forecast is criminal

      • stred
        Posted July 18, 2012 at 2:40 am | Permalink

        If public servants are paid high salaries and bonuses, then put in charge of a private company, subsidised by the taxpayer, then they will start to think like bankers. Result- large amounts of money wasted and rewards for the balls up.

      • sm
        Posted July 18, 2012 at 8:13 am | Permalink

        Given conflicts of interest elsewhere and potential incentives, would it not be reasonable to probe in detail these decisions and the rationale thereto.

        Why in a time of QE and ZIRP why would fx loans in hard currencies be a useful? Do they have an income stream in a foreign currency or foreign denominated assets?

        Who was on the other-end of the deals?

        Is this happening in other similar type institutions? Is there a pattern?
        The sums could soon add up if this was the case?

  3. Jon
    Posted July 17, 2012 at 5:54 am | Permalink

    Unbelievable and someone should get a grip here. The trains are 40% more expensive to run than on the continent, thats where the funding for these improvements can come from. Not from extra money from the taxpayer and above inflation fare increases which go back to before I can remember.

    I pay over £3000 for a season ticket plus whatever I pay as a taxpayer and they are using it to spreadbet. Is it because like the banks they are essential and so know we will have to bail them out. I could end up agreeing with John Redwood about the roads, coach travel isn’t subsidised and yet is vastly cheaper.

    • Greg Tingey
      Posted July 17, 2012 at 7:28 am | Permalink

      Actually, coach trave is subsidised – it’s just that it isn’t a “direct” subsidy.

      • Mark
        Posted July 17, 2012 at 9:16 am | Permalink

        Trains get subsidised fuel. Coaches do not, nor do they get route subsidies that are given to buses and trains.

      • lifelogic
        Posted July 17, 2012 at 10:10 am | Permalink

        Coaches are not really subsidised they pay high fuel taxes and road taxes unlike the trains do they not?

        • Bazman
          Posted July 18, 2012 at 6:15 am | Permalink

          Coaches and buses are not subsidised? Silly fantasy. The companies bleed millions from the government and local councils. You just make it up don’t you?

          • lifelogic
            Posted July 19, 2012 at 3:47 am | Permalink

            Coaches I said – clearly some buses get local subsidy.

        • Bazman
          Posted July 21, 2012 at 5:17 pm | Permalink

          Your right. Coach Concessionary Travel Scheme for the disabled and over 60’s has been cut. Hooray!

      • Jon
        Posted July 17, 2012 at 5:36 pm | Permalink

        Can’t imagine it amounts to much. I get the logic, to encourage as many people to use one vehicle.

        It means if the mainrail routes into London were converted to road just for low emission coaches travelling at 60 mph I could get there in the same time. It would just be a fraction of the price and without major delays. What if they got hydrogen powered engines sorted. It could mean travel into London from the commuter belt for a fraction of the price and better reliability. I don’t get how rail is so expensive.

        • stred
          Posted July 18, 2012 at 2:42 am | Permalink

          Hydrogen doesn’t really work, unless low carbon cheap energy is availablefor power stations. It isn’t.

          • lifelogic
            Posted July 19, 2012 at 3:48 am | Permalink

            Get fracking for gas then.

  4. Tony
    Posted July 17, 2012 at 5:56 am | Permalink

    Hi John

    I haven’t read the accounts you refer to, so it’s possible you are 100% correct, but from the detail you have provided it’s hard to tell.

    You said that companies take advantage of low rates by borrowing long and low – it’s possible NW used interest rate derivatives to do this.

    Imagine on a given day they want to borrow for 10 years. Their banker tells them they can get 5% by issuing a bond or 4.8% by issuing a floating rate note and using an interest rate swap to tranform it to fix – because of demand dynamics on the day. Fast forward a few years when rates have dropped even further – they will be showing a loss on the derivative because rates have dropped, but they still borrowed more cheaply than if they issued fixed rate.

    The same thing can happen in the inflation linked market – there is huge demand in the UK for inflation linked products (look at the returns on index linked gilts, and national savings keep having to withdraw products), it’s possible they cut a few points off their borrowing costs by issuing those products. Inflation has been high, however Network Rails income is also inflation linked, so they have a natural hedge!

    As I said, I haven’t read the accounts and you might be bang on, but it’s also possible you’re only looking a specific issues and missing the borrowing costs on the whole book.


    • Bob
      Posted July 17, 2012 at 9:25 am | Permalink

      “…but it’s also possible you’re only looking a specific issues and missing the borrowing costs on the whole book.”

      @Mr. Redwood,
      If they are competent they should be able to provide an explanation of the strategy to show whether it worked or not.

      I look forward to your findings.

      Reply: I await Network Rail’s explanation of what they are doing and why they think it is right to run things in this complex way.

      • Frederick Bloggs
        Posted July 17, 2012 at 10:04 pm | Permalink

        Yep. Shoot first and ask questions later.

  5. ian wragg
    Posted July 17, 2012 at 6:10 am | Permalink

    John, all public services like to run as investment bankers. Local authorities investing in Iceland. Network Rail as you have detailed above. Police buying top of the range BMW’s etc etc.
    I’m sure this is encouraged by Brussels to intertwine our economies and give them a European dimension.
    Why should the CEO worry abou losses when the taxpayer picks up the tab.
    Is RBS andLLloyds still buying EU soveriegn debt. Of course they are.

    • Electro-Kevin
      Posted July 17, 2012 at 7:40 am | Permalink

      It certainly seems so, Ian.

      • waramess
        Posted July 17, 2012 at 12:48 pm | Permalink

        ….and it is so boring just running a railway

        • Electro-Kevin
          Posted July 17, 2012 at 7:43 pm | Permalink

          …and unglamourous.

  6. JimF
    Posted July 17, 2012 at 6:36 am | Permalink

    You don’t think it’s because they are forced to buy abroad that they’re hedging these currency risks? Look for the answer at the costs government imposes on our manufacturers.

  7. lifelogic
    Posted July 17, 2012 at 6:38 am | Permalink

    What on earth are they playing at. I assume someone has been giving them “expert” financial advice with the intention of enriching themselves not the Network Rail. It is after all not their money so they do not mind where it is wasted on train or on the roulette wheel.

    Let us hope Wokingham gets its underpass/bridge eventually.

    Meanwhile we have “IMF now expects Britain’s GDP to expand by a meagre 0.2% this year”. Well we certainly have all the anti business and anti growth policies in place with Cameron, Clegg and Cable. This despite a population increasing by an increase of 3.7 million since 2001. So what is growth per capita?

    I am not really against some immigration where they can fund themselves and their families properly but this seems rather a lot for a small country. The BBC seemed desperate to suggest it is all due to people living longer and having more babies (and we needed these people to work in the NHS and look after the old). The truth however is that about 2/3 of this increase is immigration and their offspring many are old themselves or very young and need lot of services and benefits themselves.

    Meanwhile at the BBC (many of whom are clearly paid and pensioned at about 3+ times the going rate), it has been reported that 148 BBC stars avoiding tax by being paid through private companies. It is funny how these BBC/Guardian people all come on saying they would like to pay more tax yet arrange their own affairs this way. Typical “BBC think” lies and hypocrisy at it very best. They probably go on about better public transport and more wind turbines while driving Aston Martins too.

    I see the wind turbine subsidy is to top £1BN this year (in order to push up industries energy cost pointlessly I assume). Meanwhile another £1BN is to be lent cheaply to our rip off and non lending banks (the government owned RBS the worst of the lot) to get them lending (at about 29% APR on credit cards I assume).

    • Alan Wheatley
      Posted July 17, 2012 at 10:40 am | Permalink

      Buying Aston Martins keeps many people in this country employed.

      • lifelogic
        Posted July 17, 2012 at 4:46 pm | Permalink

        I have no problem with people buying and using them. Just the hypocrisy I dislike. When they then act, rather like Prince Charles, and start lecturing us on saving the world, while spending over a £1Million (of tax payers money) on his annual transport bills.

        • Alan Wheatley
          Posted July 17, 2012 at 9:15 pm | Permalink

          When you say “his” transport bills, do you mean those transport bills arising from journeys required of him on behalf of the state?

          Assuming the sate thinks someone needs to go, is there anyone you can suggest who would be as effective at lower cost?

          However, I do agree with you about hypocrisy.

          • lifelogic
            Posted July 19, 2012 at 3:52 am | Permalink

            Again I do not really object to his transport bill just his hypocrisy lecturing people who spent perhaps £3,000 PA on their annual transport bills.

  8. A.Sedgwick
    Posted July 17, 2012 at 6:41 am | Permalink

    Nothing really surprises me anymore about Government or Government financed operations but this comes close.

    Whilst writing, good to see the Dave and Nick sideshow on the road again!

    • lifelogic
      Posted July 17, 2012 at 7:24 am | Permalink

      The Dave and Nick sideshow was on the “rails” not the road. Trains will not give growth Greece has some very nice and expensive ones I note. Often costing more than sending every single passenger in their own personal taxi.

      What about the runways at Heathrow and Gatwick that might get some growth and not need any subsidy.

      • waramess
        Posted July 17, 2012 at 12:52 pm | Permalink

        Buying overpriced trains would of course boost the GDP figures nicely

      • A.Sedgwick
        Posted July 17, 2012 at 4:48 pm | Permalink

        You missed my irony.

        • lifelogic
          Posted July 17, 2012 at 7:43 pm | Permalink

          Sorry they surely went to the great rail promotion by car anyway – I imagine.

      • APL
        Posted July 18, 2012 at 10:02 am | Permalink

        lifelogic: “Trains will not give growth Greece has some very nice and expensive ones I note. ”

        It was a prevelidge to pay for the new Greek train set, over the last forty years. Now they can’t afford to run it, perhaps we could have it back?

  9. Mark
    Posted July 17, 2012 at 6:55 am | Permalink

    Is this legal ?

    I mean, if you are taking monies from the public purse and essencially gambling with it, is this not misappropriation of funds, or something ?

    I seem to remember a council (Labour) ran very high debts due to ‘investing’ on the stockmarket and lost large sums council tax payers monies.

    If not illegal, then I feel that it is certainly immoral.

    • lifelogic
      Posted July 17, 2012 at 7:29 am | Permalink

      All local authorities, government bodies should perhaps leave all their money on deposit with the state/bank of England until actually needed to spend. That way they would not be tempted into gambling it, lend it to Iceland or similar by financial advisers – also the government would need to borrow rather less in the mean time.

      • Denis Cooper
        Posted July 17, 2012 at 11:23 am | Permalink

        It’s hard to believe now, but apparently it used to be legal for those holding public money to invest it for their own personal gain until it was needed to be spent, and that happened at the time of the South Sea Bubble.

        • stred
          Posted July 18, 2012 at 2:47 am | Permalink

          Denis. What happened to surcharging? This seemed to make councillors think twice before wasting taxes.

          • Denis Cooper
            Posted July 18, 2012 at 8:41 am | Permalink

            Still available as a penalty, I think.

    • Mark
      Posted July 17, 2012 at 11:46 am | Permalink

      This comment is not mine: as a regular poster here, I’d ask this new Mark to distinguish himself by using a slightly different name.

  10. oldtimer
    Posted July 17, 2012 at 6:59 am | Permalink

    This is quite staggering information. I had no idea they engaged in this kind of financing, exposing themselves to potentially huge fx risks. Have they fired the finance director yet?

    • lifelogic
      Posted July 17, 2012 at 7:30 am | Permalink

      No one ever gets fired – occasionally they get a huge pay off and pension to “resign”.

      • Bazman
        Posted July 18, 2012 at 6:17 am | Permalink

        Unlike the rest of the staff you should add.

  11. Adam5x5
    Posted July 17, 2012 at 7:06 am | Permalink

    I can understand the reasoning behind the idea of investing the monies. After all, it wouldn’t be good to have a lot of money just sitting around when it could be returning an increase.

    However this just shows the problem with subsidised industries and public sector in general. They know they’ll get bailed out so its zero risk for them. The rail network should be privatised, then the taxpayer wouldn’t have to pay for this risk taking and gambling.

    But then that’d be sensible and that seems to be in short supply these days…

    • Leslie Singleton
      Posted July 17, 2012 at 10:31 am | Permalink

      Unfortunately, if privatised without subsidy it would be the railways that would be in short supply because half of them would close down. There is nothing wrong in principle with subsidy if the public benefits. As a very ordinary ex lending commercial banker including in (big ticket) foreign currency (which I do not consider to be so-called “investment” so-called “banking”) it would never have crossed my mind to consider what used to be British Railways a prospect. Of course there needs to be an international dimension (something to cover) unless one is going to get taken in by the big swinging Richards.

      But so much about the railways makes you cry. One pet hate I have is the redundant railway bridges and often beautiful viaducts that were torn down often vandalising glorious views. There might have been some reason (though not much) for not wanting the responsibility of maintaining bridges over roads (though they were built so well that they didn’t exactly fall down often) but what about bridges over rivers–was it the fish that were being protected?

      Indeed and as shown on the box recently many of these lines should have been kept in place with the occasional ghost train to keep all in order. Boggles my mind that lines in to the centre of London from Ally Pally and Noel Park were closed essentially irreversibly–it is madness even to consider the possibility that these routes wouldn’t have been of use in today’s rush hour. How many even realise that there was, indeed still is, a (modern) overground railway station at Highgate for instance?

    • APL
      Posted July 17, 2012 at 9:44 pm | Permalink

      Let’s also not forget the role government has played in encouraging this type of gambling.

      Historically low interest rates now and for the last ten to fifteen years has resulted in the search for ever higher yield compared to plain old interest on capital.

      Which orginisation has forced interest rates lower, to reduce it’s own borrowing costs?

      That’s our old friend ‘big government‘.

  12. Denis Cooper
    Posted July 17, 2012 at 7:20 am | Permalink

    How long has this been going on, and if it’s been going on for some years has it ever been questioned by MPs?

  13. Nigel
    Posted July 17, 2012 at 7:21 am | Permalink

    I don’t remember this arising with Railtrack!

  14. Greg Tingey
    Posted July 17, 2012 at 7:30 am | Permalink

    Well, I’ve been in W signalbox (when it was manned) and you’ve got a problem.
    WHERE are you going to put your bridge / underpass without huge property demolition?
    Or are you going to have two new crossings, elsewhere? And where, exactly?
    Interesting problem, and I do sympathise.

  15. alan jutson
    Posted July 17, 2012 at 7:42 am | Permalink

    I am staggered, are they running a railway track or a bank.

    What expertice do the have in foreign currancy, or did they pay someone else for these options.

    I wonder if there is any connection with any Financial Company/advisor who may have set up any of this (if indeed there was one), with a board member ?

    With regard to a flyover or underpass at the station road level crossing in Wokingham.

    Yes would be a nice idea if it could happen, but a number of houses and businesses would probably need to be demolished, and all utility services in the road would probably be affected.
    Shame that after 100 years, the water mains are being renewed in exactly that spot next week and for the next 6 weeks when Station road will be closed for the whole of that period.

    If only we had some joined up thinking with regard to projects.

    Reply: Indeed. I asked the water company to reposition their mains, but they say it cannot be done. Crossing the railway may not be possible at the current level crossing point, and has to be viewed in the wider planning context where new lengths of highway have been suggested as part of the redevelopment of Wokingham. It is easier at the Ufton Nervet crossing where there is a strong safety case for a bridge.

  16. APL
    Posted July 17, 2012 at 7:43 am | Permalink

    JR: “In the year to March 2011 Network Rail reported a loss of £251 million on these instruments by marking them to market, and in the year to March 2012 another £93 million.”

    ‘mark to market’, what does that say for their investment banks derivative assets?

    • Mark
      Posted July 17, 2012 at 11:49 am | Permalink

      Should we view it as part of the bank bailout? Given their credit risk policy, we should assume that the business has been widely shared among EU and US banks as well as UK ones.

  17. Lord Blagger
    Posted July 17, 2012 at 8:06 am | Permalink

    We all know Network Rail needs loads of subsidy to run a railway.


    There lies the problem. You believe it needs subsidy because people don’t have enough money for tickets. The reason they don’t have enough money is that you’ve taxed them to the hilt, to pay for the debts and the subsidy.

    It’s a circular argument. All designed so politicians can get the huge cut of handling other people’s money and telling them what to do.

    • lifelogic
      Posted July 17, 2012 at 7:45 pm | Permalink

      Indeed if the money were left with the taxpayer they would take the car coach as it would be far cheaper and more convenient.

  18. Lord Blagger
    Posted July 17, 2012 at 8:09 am | Permalink

    It is difficult to know why it needs to tap these more exotic bond markets, when there is a large and fairly reliable sterling bond market which would avoid all the hassle.


    Is there? It’s gone tits up because government manipulated interest rates to its own advantage (who said Barclay’s was the only one?) to hoover up huge amounts of the money available to lend. End result. No money for railtrack.

  19. NickW
    Posted July 17, 2012 at 8:17 am | Permalink

    Network Rail’s losses are a counter parties profits.

    Bank’s do not manufacture money; they take their profits from other people’s pockets.

    The Banks that sold derivatives to Network Rail did so because they expected to make a profit. It follows automatically that they expected Network Rail to lose money on the deal.

    Did Network Rail have expert, independent financial advice, (if so who?) or did they depend on the Banks for advice?

    It looks like another case of miss selling.

    • forthurst
      Posted July 17, 2012 at 9:11 am | Permalink

      One wonders whether this is the tip of an iceberg? When their banks are approached by organisations to arrange a fixed term loan, do they send in a spivvy salesman to make as much profit as possible on the sale of exotic financial instruments instead of providing a proper banking service? Are the organisations given an offer they can’t refuse by either declining advances or quoting higher initial costs for the vanilla option, much like mortgage applicants were stiched up with endowment mortgages?

      • APL
        Posted July 17, 2012 at 9:06 pm | Permalink

        forthurst: “do they send in a spivvy salesman to make as much profit as possible on the sale of exotic financial instruments instead of providing a proper banking service?”

        Having spent some time observing bankers, it’s my opinion that yes, there are an awful lot of spivs in the profession. However they largely ‘to a man’ follow their orders, mostly because their pay and bonus depend on doing so, but also because they don’t have the curiosity nor inclination to look around and see the potential results of their behavior.

        They just move on to the next ‘target’.

      • Frederick Bloggs
        Posted July 17, 2012 at 9:59 pm | Permalink

        NR is not some low IQ trailer trash. They have accountants and almost surely a dedicated treasury team all with FSA qualifications. They are considered “experts”. If they get missold something then it is their fault.

        In this case, I do not think there is anything inappropriate in funding in another currency if it can be shown to be cheaper than sterling.

    • lifelogic
      Posted July 17, 2012 at 11:58 am | Permalink

      Exactly run by fools often taking advice from the very people who will profit from their losses.

    • Frederick Bloggs
      Posted July 17, 2012 at 2:05 pm | Permalink

      Derivatives are a fee business. Banks hedge the risk.

      • lifelogic
        Posted July 17, 2012 at 7:48 pm | Permalink

        Should I buy or sell the contract asks the client?

        “What do I care” thinks the banker my commission is the same either way.

        • Frederick Bloggs
          Posted July 17, 2012 at 9:56 pm | Permalink

          Exactly. That is how a fee works.

          NR is an “expert” client according to the FSA and should probably have internal expertise in its treasury function or should seek independent advice.

    • Mark
      Posted July 17, 2012 at 5:07 pm | Permalink

      Banks usually simply take a margin between customers with opposite hedging positions. They try to ensure that whichever customer has a losing position pays up, usually in advance in the case of derivatives, where daily mark-to-market margining is standard practice.

      If banks have a surplus of demand for one side of a transaction, they can be tempted to persuade some customers of an apparent “need” to take the other side – which can result in mis-selling. Most large organisations are deemed to be professional customers, capable of assessing risks for themselves, and thus not able to sue for hedging the wrong risks.

      An exception to this came in the Hammersmith and Fulham case of a number of years ago, where the judge deemed that the council’s finance department acted ultra vires in taking on derivatives risk – i.e. it was not qualified to enter the contracts, which were annulled.

      • stred
        Posted July 18, 2012 at 2:54 am | Permalink

        Lets hope Network rail are watching this blog. Your tip could be their salvation, and the customers too.

  20. Richard1
    Posted July 17, 2012 at 8:34 am | Permalink

    Well done on unearthing this I certainly had no idea & you don’t hear it in the news. This is exactly what MPs should be doing – scrutinising where our money is going. Looking at this absurd nonsense I have 2 thoughts: 1) let the fools who have been doing this be forced from their jobs as the Barclays execs have been; and 2) next time you hear calls from Labour & Lib Dems for something called a ‘National Investment Bank’ remember how this one works.

    • uanime5
      Posted July 17, 2012 at 9:53 pm | Permalink

      If might not be in the news because the public might questions why the minister in charge didn’t know about this. Like the public is currently questioning why a certain minister didn’t know until last week that G4S didn’t have enough staff for the Olympics.

  21. A different Simon
    Posted July 17, 2012 at 8:59 am | Permalink

    “It is difficult to see why a national UK railway company with predominantly sterling revenues and sterling grant paid by the taxpayer should have currency risk problems.”

    I do take your point , it looks like either trading or a damning indictment of sterling and confidence in the UK .

    Presumably they must have some exposure to staged payments for foreign made trains though ?

    • David Price
      Posted July 17, 2012 at 12:15 pm | Permalink

      Does Network Rail own trains, apart from maintenance stock? I thought that was the other operators such as Virgin etc.

    • ian wragg
      Posted July 17, 2012 at 12:20 pm | Permalink

      This wouldn’t occur if the rolling stock was made in the UK. Like everything else, our politicians think it more sexy to spend our money on imports and put the local population on the dole.
      All our rulers are anti British and love to import good sand labour whilst taxing us to yhe hilt. Shameless the lot of them

    • waramess
      Posted July 17, 2012 at 1:00 pm | Permalink

      Agreed. This company exists on taxpayers funds and should have no need to borrow. All it’s derivaatives should be to hedge interest rates on moneys held on deposit which would have actually generated a profit.

      Fire the CEO and the Finance Director and the Treasurer

    • JimF
      Posted July 17, 2012 at 2:59 pm | Permalink

      Precisely, I would have thought. Although there is always the opportunity to purchase a Company in the UK to save them the bother:

      Any takers?

  22. Gary
    Posted July 17, 2012 at 9:13 am | Permalink

    Oh dear ! So , the steeply rising fares have nothing to do with operating costs and more to do with gambling losses. Is there ANYTHING in this country that is NOT corrupt ?

    This is what you get when you let the financial casino taint the entire economy. Someone should investigate what derivatives were sold to these dumb railway companies and if they were related to the interest rate swaps mis-sold by the banks to other businesses.

  23. Gary
    Posted July 17, 2012 at 9:18 am | Permalink

    This state of affairs highlights what Hazlitt knew long ago :

    “Like every other tax, inflation acts to determine the individual and business policies we are all forced to follow. It discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.”

  24. English Pensioner
    Posted July 17, 2012 at 9:41 am | Permalink

    This is a state run business which replaced the allegedly incompetent RailTrack which was stolen from its owners by the Labour Government.
    We’d have been far better off paying RailTrack the relatively small subsidy that they had sought than putting in place the present lot who’ve got even less idea how to run a railway.

  25. Frederick Bloggs
    Posted July 17, 2012 at 10:03 am | Permalink

    This is quite a wrong-headed blog post John, well below your usual level. And all the more amazing since I thought you worked for an investment bank part time.

    Suppose NR had debt liabilities in various currencies worth £1.2bn. And say at the time sterling-euro was approaching parity as it was a couple of years ago.

    NR get worried that sterling is going to crash versus the euro and decide to hedge the risk using currency swaps.

    They enter into £1.2bn hedging contracts which have ZERO initial value. At this moment in time the debt liabilities are still worth £1.2bn.

    Two years later, euro-sterling has not crashed and is now at 1.20 or above.

    Their initial debt liabilities are now worth about £1bn as sterling has strengthened. However the currency swaps are now a liability of £0.2bn. The net liability is still £1.2bn.


    Sure if they had not hedged then they would have made a windfall gain. But if sterling had crashed through parity then they would have made a massive loss.



    Amazed that you do not understand this.

    Reply: I understand what they think they are doing. I am saying that a sterling based company could be better off just borrowing in sterling, and lengthening its maturity structure when long term interest rates are artificially low thanks to QE.

    • outsider
      Posted July 17, 2012 at 5:20 pm | Permalink

      Dear Mr Bloggs, If your surmise is correct, NR should show a corresponding currency gain in its Statement of Total Recognised Gains and Losses, so the underlying reality should be easily testable.
      Mr Redwood’s underlying point remains. This Government’a sole economic boast is that sterling bond/interest rates are at an historic low. A public sector body (which as I recall NR is for debt statistics) should be taking full advantage of this.
      If public bodies insist on being clever, in spite of the corpses strewn along that road, perhaps we should bring back the system of borrowing through central government to get the lowest rate. As memory serves, it was called the Public Works Loan Board. In return for this benefit, as suggested by others, they should deposit spare cash with the Bank of England rather than BCCI or Icelandic banks. I suspect that this system was only abolished because some earlier Chancellor wanted to fiddle the National Debt figures.

      • outsider
        Posted July 17, 2012 at 10:37 pm | Permalink

        Update. Mea culpa, the PWLB still exists and is lending (eg) for 10 years at between 1.7 and 2.7 per cent (depending on repayment method). That does not seem excessive.

        • Denis Cooper
          Posted July 18, 2012 at 8:44 am | Permalink

          Thanks for that interesting info.

    • Frederick Bloggs
      Posted July 17, 2012 at 5:28 pm | Permalink

      Surely it depends on when they did the funding. If they did it in 2008 at the height of the crisis then foreign investors may have been the only source of funding. QE may have been a year away at the time.

      At that time sterling crashed from 1.45 to 1.10 against the euro. Surely a currency hedge would have seemed a good idea.

      I still maintain that this is a highly misleading post and is a bit rich when you have just spent the last two days moaning about how bank bashing is overdone.

    • Frederick Bloggs
      Posted July 17, 2012 at 5:31 pm | Permalink

      Also I looked at their website. They have a rolling financing program of £40bn. £1.2bn in foreign currency does not look like much.

      I really think you should retract your criticism. Especially as you have got all the anti-bank anti-NR crazies going above.

      • stred
        Posted July 18, 2012 at 3:05 am | Permalink

        Fred. Hedging is the equivalent of going to the bookies or the casino. they always win. Public bodies should not be going to the bookies. Sorry to suggest cutting your fee.

        • Frederick Bloggs
          Posted July 18, 2012 at 6:39 am | Permalink

          Hedging is buying insurance. You transfer the risk in return for a fee. You ever bought insurance ?

          I am not in banking. I have no financial interest.

      • Mark
        Posted July 18, 2012 at 9:45 am | Permalink

        Check the figures again. £6bn out of £28bn is foreign currency debt. Over £14bn is index linked.

    • zorro
      Posted July 17, 2012 at 5:35 pm | Permalink

      All these products have costs and risks……RN’s job is to spend money (including public money) on improving railway services, not dabble or hedge. It doesn’t need to pay people to do this. It needs people who are competent at running railways. As John says, they could have borrowed long term on preferential terms at low interest rates. It has been clear for a long time that the government’s only way to mitigate this crisis politically (in their minds) is slow inflationary default through ZIRP and QE…….


    • Leslie Singleton
      Posted July 17, 2012 at 5:39 pm | Permalink

      Mr Bloggs seems to think it not worth comment that in his example Network Rail has large currency liabilities. I wonder what a British railway company has by way of currency assets that would need funding in this way.

      • Frederick Bloggs
        Posted July 17, 2012 at 9:42 pm | Permalink

        It is funding its sterling requirements by borrowing in another currency. It then swaps that currency to create an effective sterling liability. It is can do this more cheaply than funding directly in sterling then it is a good deal.

        • sm
          Posted July 18, 2012 at 9:04 am | Permalink

          Why take the counterparty risk? Why take the complexity of the ‘paper chain contracts’.

          If this was full hedge why is there a loss? I would expect the economic gains and loss to balance?

          • Frederick Bloggs
            Posted July 18, 2012 at 3:07 pm | Permalink

            I am sure that the contract is uses collateral posting so there will be no significant counterparty risk. In any case, it is the bank which is exposed to NR.

        • Mark
          Posted July 18, 2012 at 9:41 am | Permalink

          A bank could equally procure the funds and hedge the risk, simply offering vanilla sterling to Network Rail. That’s what they did with £800bn of our mortgages that rely on overseas borrowing.

          • Frederick Bloggs
            Posted July 18, 2012 at 3:18 pm | Permalink

            Yes but NR is not a mortgage. It is a highly rated uk company with an implicit government guarantee. That makes it of special interest to investors seeking highly rated investments.

  26. Frederick Bloggs
    Posted July 17, 2012 at 10:07 am | Permalink

    By the way a loss to NR is not a gain to the investment bank who sold the swap. The investment bank will also have hedged the risk so that they will have an offsetting position. They will simply collect a fee from the trade. This risk will ultimately be sitting in a hedge fund or in your pension fund or insurance company.

    • alan jutson
      Posted July 18, 2012 at 7:51 am | Permalink


      I see lots and lots and lots of commissions, all earned out of a taxpayer funded operation.

      Nice work if you can get it, and you do not even have to catch a train to do the business.
      Couple of keystrokes and hey presto.

  27. Caterpillar
    Posted July 17, 2012 at 10:26 am | Permalink

    Well I am going to have to be dumb here and ask whether someone can clarify whether this is just a symptom of the structure?

    I thought (perhaps mistakenly) that Newtwork Rail does not have shareholders, including the major subsidiary NR Infrastructure. Hence finance is raised through debt, which is done through NR Infrastrucutre Finance (…”their own investment bank”???), the accounts of which are consolidated with NR Infrastructure. Errr, I’d guess that if an organisation doesn’t have shareholders and needs around £80bn it might be quite broad in sources of debt financing.

    So as I say, sorry for probably a dumb question, but are JR’s observations largely a symptom of the structure?

    • Caterpillar
      Posted July 17, 2012 at 4:46 pm | Permalink

      I think I should have typed £40bn not £80bn.

  28. norman
    Posted July 17, 2012 at 10:44 am | Permalink

    The cynic in me suggests that if these instruments make a loss the directors will shrug their shoulders and write it off due to the uncertainty in the markets.

    If they come good they’ll pat themselves on the back and deposit a nice performance related bonus in the bank account for doing such a good job at investing taxpayers money. And why shouldn’t they be rewarded for making us taxpayers money?

    Maybe these directors don’t get bonuses and I’m being harsh in which case apologies but I doubt few of us would be surprised if there was some bonus element involved in all this.

  29. Alan Wheatley
    Posted July 17, 2012 at 10:50 am | Permalink

    Network Rail looks like another likely candidate for being converted to a limited company where he shareholders are the private train operating companies. After all, they have most to gain from the railway infrastructure being run efficiently and effectively.

    Train operating companies would get their shareholding as a consequence of receiving an operating licence, and would return their shares when the licence ends. Shares would not be able to be traded. The Network Rail board would be responsible to their shareholders. Infrastructure investment would come from shareholders.

  30. Denis Cooper
    Posted July 17, 2012 at 11:14 am | Permalink

    A long time ago now, but didn’t the aerospace part of privately owned Rolls Royce go bust partly because it had NOT hedged against exchange rate risks on the RB211 engine?

    • outsider
      Posted July 17, 2012 at 5:35 pm | Permalink

      Dear Mr Cooper, Yes it is a long time ago but I believe that R-R went bust because the RB211 had design problems (bird strikes smashed the original carbon fibre blades) , so it could not meet its delivery contracts and faced overwhelming financial penalties. Hard to hedge against that. Just don’t promise what you cannot deliver.

      • David John Wilson
        Posted July 17, 2012 at 10:38 pm | Permalink

        Are you sure it wasn’t hedge sparrows that caused the problem?

      • Denis Cooper
        Posted July 18, 2012 at 8:56 am | Permalink

        That may well be so, but as I recall adverse movement of the pound-dollar exchange rate was also a factor.

    • Leslie Singleton
      Posted July 17, 2012 at 5:43 pm | Permalink

      Dear Mr Cooper, Yes but and it is a big but, Rolls Royce was selling abroad, big time, in particular to Boeing, so had currency receivables which needed hedging.

  31. Lola
    Posted July 17, 2012 at 2:38 pm | Permalink

    Borrowing in foreign currencies! WTF? Are they utterly deranged? And in index linked bonds! Words fail me. What. A. Load. of. Plonkers.

  32. Frederick Bloggs
    Posted July 17, 2012 at 3:45 pm | Permalink

    There is nothing wrong with borrowing in a foreign currency. Suppose they can issue at Libor + 10 bp in Japan but in the UK they need to pay Libor + 50. It is clearly cheaper to issue in Yen and then swap the Yen liability back to Sterling s0 hedge the currency risk. It is a no-brainer.

    • outsider
      Posted July 17, 2012 at 5:36 pm | Permalink

      “No-brainer” is a rather ambiguous term.

    • Leslie Singleton
      Posted July 17, 2012 at 6:10 pm | Permalink

      Dear Mr Bloggs, Sorry but you seem a trifle unaware how a basic currency swap works, meaning (it’s called completing the square) after factoring in the cost of the necessary covering forward foreign exchange deal (else just have a long term exchange risk in the repayment of the currency liability) one is left with no significant advantage (and a fair bit of complexity with accounting for the forward interest). If the difference between the spot and forward exchange rates did not make this so the market would trade against the difference and make money for jam. In other words unless you want to carry an exchange position (which many have learnt to their cost is not such a good idea–remember the home owners who thought Swiss Franc and other mortgages were a good idea) the apparent lower interest rates simply do not exist. Different story if there is currency income to service the currency liability but why would Network Rail have any of that?

      • Frederick Bloggs
        Posted July 17, 2012 at 9:49 pm | Permalink

        I do know how interest rate swaps work.

        Loads of companies fund in foreign markets even when they have no foreign assets. Even countries sometimes fund in foreign markets. They use currency swaps to eliminate the fx risk. Sure there is a cross currency basis swap adjustment, but even after that the funding may be cheaper. It depends on the issuer.

        Those idiots who funded their mortgages in foreign currencies were not doing what NR is doing. They were actually borrowing in the foreign currency like you going and getting a euro mortgage and then taking a resulting massive fx risk. What NR is doing is borrowing in a foreign currency and then swapping it back into sterling thereby eliminating the currency risk.

        Reply: Your passionate defence of Network Rail is not based on calculations of the true cost of their funding. Nor will they or we kn ow the true cost of funding until all has been repaid. The issue I am raising is should a sterling based nationalised busienss be taking these sort of financing risks at all? Both index linked and foreign currency funding can turn out to be very dear if they are n ot careful. There is no justificaiton of the policy provided so far.

        • Frederick Bloggs
          Posted July 18, 2012 at 6:25 am | Permalink

          I am not passionately defending NR. My claim is that you have made an uninformed accusation of incompetence or bad financial management. You are a famous policitian and a well-read blogger and supposedly an investment banker so what you say carries weight. I think you got ahead of yourself on this one because you probably do not understand derivatives or foreign currency funding, which is odd given your background.

          For example, a phrase like “we will not know the true cost of funding until is has all been repaid” is just wrong. If I borrow for 10 years at Libor plus 20bp in JPY and then swap it to sterling so that after the basis swap I am paying effective GBP Libor + 30bp then I do know the cost of funding for the next 10 years. If you want this as a fixed rate then you do a standard fixed for floating IR swap and you know that you will be paying say 4% a year. You can know this now.

          I find your comment “there is no justification of the policy so far” is a bit odd – you write a post and then when someone tells you that you may have got it wrong, you then claim that NR needs to justify it rather than say that you could be wrong. I think the onus is on you to your homework.

          As I said below, companies often borrow in foreign markets. In Japan for example, there is a large retail market and so investors may be happy to receive a lower fixed rate than sterling investors. Or the US credit markets which are much bigger than the UK credit market may be better able to accept a large NR issuance at a lower coupon. It might also be good policy for NR to diversify its sources of funding. Also note that there has been QE in the US so their rates are low too. Rates are also very low in Japan.

          No overall I am a bit disappointed in this post. It may be that NR have done something wrong. But I would tend to assume that they are smarter than that until I see some clear case of incompetence which this most certainly is not.

          Reply: I think it important that a taxpayer owned and backed company like this should engage in debate about why it chooses to borrow in this way, and to explain how it thinks it has protected the taxpayers interests by the derivatives it has acquired. I have every right to a) point out it is doing this b) point out losses recorded in its recent accounts from mark to market c)ask for an explanation of its funding and derivatives policy. I also want Network Rail to explain to me why they sat in my office and told me they were starting work on a new station in Wokingham at the beginning of 2012 and have so far not made any visible start on the promised project.

          • Mark
            Posted July 18, 2012 at 12:56 pm | Permalink

            We could also do with some transparency from ORR. The regulator quangos are not asked serious questions: see FSA, OFGEM, OFWAT.

          • Frederick Bloggs
            Posted July 18, 2012 at 3:22 pm | Permalink

            Of course you have a right to do this. That is your job. But you do not have the right to throw about accusations of mismanagement and incompetence simply because you got the wrong end of the stick.

            If it proves to be the case that mismanagement or wild speculation was at the root of these losses then I would hope that a ton of bricks land on NR. But if, as seems more likely, this was a serious effort to get cheap funding, to hedge out currency exposure, to match income to liabilities and to diversify funding sources then you look a bit silly.

            Reply: I did not use the word incompetent. I was pointing out interesting entries showing losses in their accounts and suggesting easier ways of financing their business. Why are you so defensive on their behalf?

          • Frederick Bloggs
            Posted July 18, 2012 at 3:23 pm | Permalink

            Actually strike “silly” and replace it with “premature”.

          • Frederick Bloggs
            Posted July 18, 2012 at 5:14 pm | Permalink

            Why am I defensive ? Because after reading for two days on your blog about how the bankers are pilloried versus other professions I was expecting a more considered and understanding approach to banking issues and subtleties like financing.

            Instead you slag off NR for doing something which might actually be a perfectly good policy that saved tax payers money.

            When called up on it by me, you then start saying that NR need to justify this. Now if I was a serious politician I would ask NR first about what they did and if I did not get any satisfactory response, then I would go public.

            At the same time, you stoke the anti-banker anti-finance feelings of the readers of this blog many of whom would not know the difference between a floating and a fixed rate bond. Finance is not a simple subject. I teach it. There are complexities and what may look odd to someone who does not know anything could be perfectly fine when you go through the structure carefully.

            Bankers do a needed job. Raising finance for companies is not a trivial matter. Matching investment needs to financing needs requires distribution and market knowledge and a risk-taking ability. Sure, banks played a big role in the crisis, and the politicians have used them to deflect the blame from their massive failures, but it gets a bit much to read this stuff here as you are a banker yourself and so should know about this.

            At the end of the day it looks to me as though you have a large pet peeve about some NR work that was not done in Wokingham and you saw this derivative loss and decided to use it as a stick to beat NR. Fair enough. I guess that is modern politics.

            PS I have no connection with NR. I avoid the trains as much as possible. And I am not a banker.

        • Leslie Singleton
          Posted July 18, 2012 at 10:08 am | Permalink

          I don’t know whether you know about interest rate swaps because we are not talking about them but currency swaps.

          Back to currency swaps if you cover the exchange position (created when you sell the borrowed currency spot in to sterling so you can use it) by buying currency forward (so as to be able to repay the borrowed currency at maturity–a closed position in other words) then the interest rate adjusted for the spot and forward foreign exchange difference comes back to the sterling borrowing cost. Were that not so the market would soon close the gap.

          • Frederick Bloggs
            Posted July 18, 2012 at 3:13 pm | Permalink

            I am talking about cross-currency interest rate swaps.

            – I have a USD liability which I am funding at USD Libor + 20bp for 10 years
            – I do a cross currency interest rate swap in which I receive USD Libor + 20bp and pay GBP Libor + 20bp roughly. This has zero initial cost. There will be a basis swap adjustment but let’s ignore that for simplicity. This swap has no cost.
            – Result, I pay GBP Libor + 20bp as the other payments cancel out.
            – Eh voila I have GBP funding at or close to the foreign funding spread which may be better than the Libor + 40 that I would have needed if I had issued in GBP.

  33. Derek Emery
    Posted July 17, 2012 at 4:49 pm | Permalink

    Even banks are rubbish at running investment vehicles so it is hard to see why there would be any hope of Network Rail having any capability of running a derivatives business successfully.
    It’s only because Network Rail is part of the generally financially incompetent Public sector that it can get away with making these losses year in year out. In the private sector this business would have gone bankrupt and closed down. Make Network Rail a private company so it is forced to fund its own losses. See how long it keeps the loss making derivatives arm open then.

    • stred
      Posted July 18, 2012 at 3:16 am | Permalink

      The Kirkaldy Kid made it a private company but owned by the taxpayer! How did his handlers let that Happen?

  34. Mark
    Posted July 17, 2012 at 6:04 pm | Permalink

    The accounts can be found here:

    Note 19 on page 85 lists the borrowings. They comprise:

    £m______2012___2011___2012 %




    • Mark
      Posted July 17, 2012 at 9:11 pm | Permalink

      The USD borrowings are short term – average time to repayment 2 years, longest 4 years. Average times for the other currencies are NOK 14 years, Yen 9 years, Can$ 4 years, Aus$ 4 years, CHF 9 years, GBP 20.4 years, of which GBP index linked 25.8 years (longest 40 years), vanilla GBP 9.8 years.

      The index linked risk is substantial: it is very likely to prove much more expensive in the longer term than normal bonds because the inflation risk over 25 years is very high.

      The network as a whole is valued at £43.1bn. You have to search elsewhere to find that it covers about 10,000 route miles and 20,000 track miles (I can’t think why this is omitted from the report, as is the mileage involved in investment either as renewal or upgrading/addition, so we could assess value for money in procurement).

      The valuation methodology is circular:

      The railway network is carried at its fair value, which is measured as the estimated future cash fl ows that are expected to be generated in perpetuity, discounted at the Company’s pre-tax rate of return, as set by the independent rail regulator, the Office of Rail Regulation (the ORR), in its Access Charges Review. This rate reflects the risks and opportunities that exist in the regulated market for railway infrastructure assets and equates to the cost of capital for this market.

      i.e. the network is valued at whatever the cost of capital works out to be. Clearly there are incentives here to tweak the figures on the part of the ORR who control the process, so that it appears they are doing a good job in the short run: by the time the consequent problems arise the present regulator will doubtless be long gone. These incentives may drive the use of long term index linked debt.

      Alternative valuations include a full replacement cost estimate of £75bn, and a historic cost estimate of £38bn. (Note 12) It is of some concern that the level of spending on “network renewal” is around £2.5bn p.a. (Chart p. 9), substantially above the level of depreciation at £1.3bn.

      • Frederick Bloggs
        Posted July 18, 2012 at 7:15 am | Permalink

        Given that their revenue is index linked (fares always seem to increase faster than inflation and I think are linked explicitly to inflation) I would imagine that their index risk is pretty minor. Indeed this is one way in which they have closely matched their liability to their income.

      • Mark
        Posted July 18, 2012 at 9:36 am | Permalink

        I should perhaps have pointed out that since revenue is indexed to RPI, the policy seems to require at least 50% of the debt is also. Perhaps if debt funding were assessed on a vanilla basis only 50% of track charges need be RPI indexed.

        Another source of funds for you Wokingham crossings is the £300m the DfT plan to waste on HS2 this year.

    • Tony
      Posted July 17, 2012 at 10:03 pm | Permalink

      The derivative instrument section (note 20, p97-88) sets out the derivative assets and liabilities.

      Derivatives that are categorized as ‘Cash flow hedge’ or ‘Fair value hedge’ have met certain standards for offsetting the risk on a corresponding piece of debt – see the policy at the bottom of page 73. Something designated as cashflow hedge or FV hedge has satisfied the auditors that the derivative meets certain criteria for hedging debt.

      Non-hedge accounting derivatives may still be hedging debt, but aren’t a close enough match to qualify for hedge accounting. These positions should be marked-to-market, the fair value of a hedge accounted derivatve can be tied to the debt it is hedging.

      Of the mark-to-market derivatives there are cross-currency swaps, interest rate swaps, forward fx contracts, real interest rate swaps and gilt locks. In vanilla form none of those seems particularly suprising for a company with multi-currency, multi-index borrowing. Compare to section 21 of the Tesco 2012 Annual Report.

      Note also that there are sizable changes of the notionals of the derivatives – this indicates continued activity.

      The marks versus the notionals are fairly chunky in some cases, but not outragous. The forward starting real interest swaps and gilt locks are marked down almost 50% but then they are hedging borrowings out to 2052 so I’d expect them to be volatile.

      There isn’t enough information here to conclude if the company is hedging or if it is speculating, or whether it is using derivatives intelligently or whether it is completely out of its depth. I’m not an accountant but to me there is nothing here to suggest widespread wild speculation or gross incompetence. It may of course certainly be happening at some levels.

      The debit issuance program is £28bn (p85), and the interest cost is £1.3bn (p76 note 9). That’s not too bad for a company borrowing out 30 years (look at the sizes of the debt in 2037 and 2047).

      What will be interesting is to what extent that cost is locked in (will the costs go up as hedges mature or hit certain dates?) and how the company is managing the inflation risk on those long-dated inflation swaps.

      The company should, of course, be able to answer these questions intelligently!

  35. John C
    Posted July 17, 2012 at 6:13 pm | Permalink

    “They seem to arise mainly because the company has a penchant for borrowing in foreign currencies. It has chosen to borrow in Swiss francs, US dollars, Norwegian krone, yen, Canadian dollars and Australian dollars. It is difficult to know why it needs to tap these more exotic bond markets, when there is a large and fairly reliable sterling bond market which would avoid all the hassle.”

    Why do I sense that they were advised by (some well known investment bank-ed)

    It’s not just private individuals who get mugged.

    • APL
      Posted July 17, 2012 at 9:24 pm | Permalink

      John C: “Why do I sense that they were advised by (some well known investment bank-ed)”

      Of course that ‘well known investment bank’ wouldn’t in a million years be Goldman Sachs, would it!

      But didn’t they have a hand in helping the Greek government wriggle it’s way into the Euro, which turned out to be a very good deal, if not for the Greeks, then definitely for Goldman.

      And weren’t they the organization, along side many others it should be said, that converted to a bank holding company in order to tap the free money at the FED TARP?

      Reply: I do not kn ow which banks advised Network Rail, and advise against making allegations when we do not know. I regard the Greek government as being primarily to blame for the figures which they submitted to the EU. Nor can we say the advice to Network Rail was wrong or not welcome – I am questioning why the experts at Network Rail wish to borrow in these exotic ways. Of course Investment banks will be very willing to help a company like that if it wants to pay and play.

      • APL
        Posted July 18, 2012 at 8:00 am | Permalink

        JR: “Of course Investment banks will be very willing to help a company like that if it wants to pay and play. ”

        Yes, but then when their collective actions bring the whole financial system to it’s knees, they* should not be rewarded by special treatment and financial injections all at the tax payers expense.

        *they in this case is no one specific FI, rather the cancer is pervasive through out the whole sector.

        Enough financial sector scandals have emerged over the last four years, to know the problem is pervasive in the sector.

        Bernie Madoff, Alan Stanford, AIG, ‘The London Whale’, PFG, Bank of Scotland – bankrupt, RBS – bankrupt.

        Before Bazman et al say this is a result of insufficient regulation, no it is a result of regulatory capture. There is no system of regulation where regulatory capture couldn’t happen.

        What we need is a system where a failing company is bankrupted and goes out of business, not one aka PFG that can hide it’s balance sheet and lie about it’s bank accounts and get away with it. What were the regulators doing there?

    • Frederick Bloggs
      Posted July 17, 2012 at 9:52 pm | Permalink

      Canada and Australia and the US and Switzerland are not exotic bond markets. The Norwegians have a huge petrol fund that probably made them a good offer of cheap funding.

      • Leslie Singleton
        Posted July 18, 2012 at 10:13 am | Permalink

        But that just boils down to the railways taking open positions in the relative currencies which is ridiculous. They “cannot run a railway” as they say never mind predict future foreign currency (exotic or otherwise) exchange rates.

        • Frederick Bloggs
          Posted July 18, 2012 at 3:16 pm | Permalink

          (expletive deleted) Read my comments. The derivative positions were used to hedge the currency risk. The gain made on the liabilities due to the strengthening of sterling since 09 were offset by the losses on the derivatives.

          Reply: Do you know the full numbers? What about the interest rate positions?

          • Frederick Bloggs
            Posted July 18, 2012 at 4:52 pm | Permalink

            No. I am surmising like you are.

            Derivatives, in particular the cross currency interest rate swap, hedges the currency risk and the rate risk by converting a foreign currency coupon into a domestic currency coupon. Do it the right way round and you have a currency and interest rate hedge.

          • Mark
            Posted July 18, 2012 at 5:01 pm | Permalink

            Changes in mark-to-market positions apply to the financial year, not to the time since 2009.

            The pound fell very slightly from $1.603 to $1.599 over the financial year ended March 31 2012. Exchange rate risk does not explain the derivative losses.

          • Leslie Singleton
            Posted July 18, 2012 at 5:15 pm | Permalink

            I have read your comments for my sins and they or one in particular involves a pre-existing presumably net currency (dollar) liability and the main point is disbelief that a British railway company would have any such (and apparently huge) foreign currency liabilities in the first place–unless as a part of some idiocy in the past.

  36. Bazman
    Posted July 18, 2012 at 6:18 am | Permalink

    How many councils and government departments are involved with this financial gambling?

  37. Mark
    Posted July 18, 2012 at 10:57 am | Permalink

    Is this pork barrel politics?

    …the announcement of a long-awaited “electric spine” from Southampton to Yorkshire has fuelled suspicions that the project is partly aimed at shoring up support for Mr Clegg in his Sheffield constituency. A large part of the package will be the electrification of the Midland Mainline from London to Sheffield.

    Mr Clegg, the MP for Sheffield Hallam, is among the MPs who have been openly lobbying for the scheme.

  38. Lindsay McDougall
    Posted July 19, 2012 at 1:23 pm | Permalink

    Network Rail was created in the days of Messrs Blair, Brown, Byers and Prescott. So you would expect it to believe that it had financial expertise. Understanding this will enable you to answer your own questions.

    • Lindsay McDougall
      Posted July 19, 2012 at 8:07 pm | Permalink

      The most important fact is that Network Rail owes £33 billion. It is only able to borrow because it is backed by the UK state but as I recollect it, this debt is off balance sheet.

  39. james rimmer
    Posted December 25, 2012 at 10:08 am | Permalink

    Look at the fiasco the last time the railways were privatised.No regulation,safety went out the window.Railtrack whom Network Rail took over from was being bled dry by every tom Dick and harry contractor.The reason Network Rail are in so much debt is because of the funds they have invested in the infrastructure that was basically falling to bits before the companies creation.If people want to talk about wasted funds look at the banking fiasco.

  • About John Redwood

    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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