The Rt Hon David MILIBAND Secretary of State for Foreign Affairs Foreign and Commonwealth Office King Charles Street London SW1A 2AH United Kingdom Commission européenne, B-1049 Bruxelles – Belgique - Europese Commissie, B-1049 Brussel – België Tel.: 00- 32 (0) 2 299.11.11.

EUROPEAN COMMISSION

Brussels, 13.05.2009 C (2009)3571 final

Subject: State aid N 420/2008 – United Kingdom

Restructuring of London & Continental Railways and Eurostar (UK) Limited.

Sir,

1. PROCEDURE

1. By letter of 26 August 2008, registered on that day, the United Kingdom notified an operation (hereinafter referred to as "the operation") aiming at financially re-organising London & Continental Railways Limited (hereinafter also referred to as "LCR") and at restructuring Eurostar (UK) Limited (hereinafter referred to as "EUKL").

2. By email dated 11 September 2008, registered on that day, the United Kingdom provided some additional information regarding the notified restructuring.

3. The Commission requested additional information by letter of 29 September 2008. By letter of 10 October 2008, registered on the same day, the United Kingdom provided additional information concerning the restructuring plan. By letter of 2 December 2008, registered on the same day, the United Kingdom amended its notification and provided additional information accordingly. On 20 April 2009, the United Kingdom supplemented the notification with additional elements.

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2. DESCRIPTION OF LONDON & CONTINENTAL RAILWAYS

4. The operation presented by the United Kingdom as a restructuring of LCR and its subsidiary EUKL. LCR is the developer of High Speed 1 (HS1), the high speed rail link between London and the Channel Tunnel and the owner of Eurostar (UK) Limited, which is the UK arm of Eurostar.

5. The United Kingdom considered that this operation has become necessary due to two majors elements: on the one hand, there is a new context characterised by both the successful delivery of HS1 in November 2007 and the forthcoming opening to competition of international rail passenger transport; on the other hand, there is an operational need to now separate train and infrastructure operations, which have been up to now managed by LCR.

2.1. General presentation

6. In March 1994, the UK Government launched a public works concession procurement for the Channel Tunnel Rail Link (CTRL) project, now called High Speed 1 (HS1).

7. LCR is the consortium company formed to bid for the CTRL project. LCR won the competition and, in February 1996, received the concession for the CTRL (signature of the Development Agreement).

8. The shareholders of LCR are the following: Shareholding

Bechtel 22.41%

UBS (previously S.G. Warburg) 22.41%

National Express 20.94%

SNCF 13.60%

EDF Energy (previously London Electricity) 13.18%

Arups 2.76%

Halcrow 2.43%

Systra 2.27%

Total 100.00%

2.2. London & Continental Railways' businesses

2.2.1. Construction of High Speed 1

9. High Speed 1 (HS1) between London St Pancras and the Channel Tunnel was the first new railway to be constructed in the UK for more than 100 years. It was built in two sections:

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- Section 1 linked the Channel Tunnel to North Kent and opened in September 2003;

- Section 2 completed the railway to St Pancras International via new stations at Ebbsfleet and Stratford and was opened for Eurostar international services on 14 November 2007.

10. HS1 links London with the capital cities of France and Belgium and is the UK leg of the Paris-Brussels-Köln-Amsterdam-London (PBKAL) EU trans-European network (TEN) priority project. HS1 is 108 km long and can support train operations at line speeds of up to 300 km/h. It is the physical connection between the UK rail network and the fast-expanding European inter-operable high-speed rail network.

11. Since the completion of HS1, the traffic has increased and the number of international passengers in the first half of 2008 is […]*% ahead of the corresponding period a year earlier.

12. The new line and associated services deliver a wide range of economic and policy benefits:

- journey time improvements on the international and domestic routes;

- free up of capacity on the existing network, when the demand on the UK railway market is growing fast;

- a critical component of London's delivery of the 2012 Olympic Games;

- an important contribution to economic regeneration;

- a modest but useful environmental benefit, with a result of modal shift from air to rail.

13. Since 14 November 2007, the new railway HS1 is fully completed. It was completed on time and within budget. Following the completion and opening of HS1, LCR's project construction activities have been wound down. This leaves LCR with three operating businesses as shown in the diagram below:

2.2.2. HS1 infrastructure and stations

14. The UK government1 is the owner of the whole of the HS1 route, which includes the HS1 track, station and depot infrastructure. The UK government has agreed to grant a lease to HS1 Limited (formerly URN2) and CTRL

* Covered by the obligation of professional secrecy 1 In the present decision, the Secretary of State is referred as the UK government. 2 Union Railways (North) Limited, now renamed HS1 Limited (HS1 section 2).

HS1 railway infrastructure and stations

Participation in Eurostar (EUKL)

Development land interests at Stratford and King’s Cross

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(UK)3 of the entirety of the HS1 track, station and depot infrastructure apart from certain electrification assets which the two companies lease from EDF.

15. The HS1 railway is operated under contract by NR (CTRL), a wholly-owned subsidiary of Network Rail Infrastructure Limited, which owns and operates the UK domestic rail network. Under the terms of the operator contract, NR (CTRL) manages the operations, maintenance and renewal (OMR) of the HS1 railway and is reimbursed its costs for so doing, together with fees and performance incentives. These costs are then passed on to users of HS1 as an element of HS1’s access charges.

16. The principal sources of income for the infrastructure activities of LCR are access fees charged to the users of the infrastructure in respect of both international and domestic train services on HS1.

17. At present, the only operator of international passenger services on HS1 is Eurostar. However, the liberalisation of the EU rail passenger market from 2010 will make it possible for other operators to apply for access to operate international passenger services on HS1.

18. Through EUKL, Eurostar has agreements for access to HS1 entitling it to operate up to 8 train services an hour in each direction on the railway. In practice Eurostar will operate just over 330 services a week in its first year of operations on the completed railway.

19. Apart from access charges, LCR’s other principal sources of revenue via HS1 are expected to be rental income from retail outlets and the sale of advertising space at St. Pancras station, and car-parking income at Ebbsfleet station.

2.2.3. Eurostar UK Limited (EUKL)

20. LCR wholly owns EUKL which conducts LCR's participation in the delivery of the Eurostar service ("Eurostar").

21. Eurostar is operated as an unincorporated international railway grouping of EUKL, SNCF and SNCB. In 1998, LCR contracted the management of EUKL to ICRR, a consortium company consisting of:

- National Express (40%);

- SNCF (35%);

- SNCB (15%);

- British Airways (10%).

22. The creation of ICRR was approved as a merger by the Commission4. The management contract between EUKL and ICRR expires in December 2010.

23. Of the 330 services operated each week by Eurostar, just over half are services between London and Paris, which account for just over 70% of Eurostar’s revenues, and around a third are services between London and Brussels accounting for just over 20% of Eurostar’s revenues. The remainder

3 Channel Tunnel Rail Link (UK) Limited (HS1 section 1) 4 Case No. IV/M:1305 - Eurostar

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are services to Lille, Marne-la-Vallée (Disneyland) and other destinations such as Avignon and Bourg St. Maurice.

24. Eurostar revenues and certain costs are shared between EUKL, SNCF and SNCB under so-called ‘revenue sharing protocols’. There are two protocols:

- A “Bipartite Protocol” between the British Railways Board (BRB) and SNCF covering the London-Paris route. Although BRB, which is wholly-owned by the UK Government, remains the UK counter-party to the protocols, it has entered into a Back-to-Back Agreement with EUKL under which EUKL assumes all of BRB’s rights and obligations (other than those relating to freight, which were assumed by English Welsh and Scottish Railways Limited). EUKL is therefore the effective counter-party to the protocols;

- A “Tripartite Protocol” between BRB (effectively EUKL through the back-to-back arrangements), SNCF and SNCB for the London-Brussels route.

25. EUKL sells about […]*% of Eurostar ticket revenues and, under the protocols, retains around […]*% of the proceeds5. As well as covering the sharing of revenues, the protocols cover the division of the direct operating costs incurred in operating the Eurostar service (including payments for access to the Channel Tunnel) and capital expenditure on rolling stock. The principles of the cost sharing are that:

- Each partner railway covers the costs specific to operations within its country (for example track and station access charges and station operation costs);

- Train maintenance costs are shared according to the proportion of journey minutes and train kilometres on each network and the capital cost of the rolling stock is shared in proportion to the journey minutes on each network;

- Eurotunnel costs (Channel Tunnel usage charges and contribution to operating costs) are shared equally between SNCF and EUKL.

26. In 2007, Eurostar revenue from passengers travelling on inter-capital services was £550m, of which EUKL’s share was approximately £[…]*m. After payment of operating costs and access charges for use of the Channel Tunnel and HS1, EUKL had an operating deficit of around £[…]*m of which current HS1 access charges amounted to £128m Passenger numbers for 2007 were (1000s):

London/Paris […]*

London/Brussels […]*

London/Lille/other […]*

Total: […]*

5 This is because revenue is split in proportion to distance travelled and journey times within the UK, France and Belgium.

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2.2.4. Development land interests at Stratford and King's Cross

27. For the realisation of HS1 within the Development Agreement signed in 1996, LCR acquired rights to develop and construct on a land at Stratford and King’s Cross and an interest in the development of land at Ebbsfleet, which is now owned by Land Securities.

28. Under the terms of the acquisition, the UK government is entitled to a claw back share of LCR’s development profits at King’s Cross and Stratford.

29. The UK authorities informed the Commission of an existing joint venture for the development of the King's Cross site, for which changes may be notifiable to the Commission as a concentration with a Community dimension.

2.3. Previously approved measures

30. The UK’s intention was for the HS1 project to be developed and operated by the private sector with the private sector taking passenger revenue risk but with only initial support from the UK.

31. However, in light of poorer passenger revenue from EUKL than originally projected, LCR was unable to finance HS1’s construction. This led to government support for the project and the involvement of Railtrack as the intended ultimate owner of the infrastructure. Railtrack’s subsequent financial difficulty led to further restructurings of HS1 and to the current configuration of the project.

32. According to the UK authorities, their approach throughout the project has been to maximise the transfer of risk to the private sector and to minimise the level of public support to the project. The UK support has however been instrumental in enabling the project to proceed and has also been a key factor in its efficient delivery.

33. The Commission adopted several successive decisions regarding the HS1 project considering either that the measures were State aid compatible with the common market, or that they were not State aid.

2.3.1. State aid prior to the launch of HS1 and the transfer of EUKL to LCR

34. Several State aid measures were approved by the Commission before the launch of the HS1 project and the transfer of EUKL to LCR6. These measures were State guarantees for the acquisition of rolling stock, as described below:

- State guarantee for the leases of seven Eurostar train sets which EUKL entered into with commercial bank lessors in 1993 and 1994. The initial capital value of the leases was £190m and the capital value at 31 December 2007 was c. £180m. The lease terms run to between 2017 and 2021 and EUKL pays a guarantee fee to the Secretary of State of 0.5% per annum of the initial capital value rising to 2% per

6 Commission decision of 14 July 1994 No 480/93 – United Kingdom - Lease of international passenger rolling stock guarantee for rolling stock; Commission decision of 16 January 1995 No 613/94 – United Kingdom – Government guarantee for leases of European Night Stock.

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annum from the end of 2010. The guarantee fee continues for three years after the term of the leases. The current cost of prepaying the leases under the terms of the lease agreements is estimated at £183m7;

- State guarantee on part of the obligations under rolling stock leases of European Night Services Limited (ENS), a majority owned subsidiary of EUKL. ENS was set up to develop sleeper train services between the UK and Continental Europe using HS1 and the Channel Tunnel. However, it was decided in 1997 to terminate the sleeper services project and these leases were terminated in 1998. Then, the Secretary of State loaned EUKL funds to meet its share of the termination payment of £110m. It was subsequently agreed that the loan would be repaid out of EUKL's operating cash flow from 2021. The Secretary of State will cancel this loan as part of the present restructuring.

2.3.2. Commission Decision N 234/96 of 22 May 1996 (1996 Decision)

35. When LCR signed the Development Agreement in 1996 following a tendering procedure, the UK agreed to make a number of contributions to the project, both financial and in kind, which were notified to the Commission.

36. The in kind contribution to LCR included:

- EUKL; - URL, the company which had taken forward the CTRL project from

inception; - Brownfield development sites at King’s Cross and Stratford (and an

interest in a greenfield development site at Ebbsfleet). 37. The grants and financial support from the UK were as follows:

- Capital Grant of £810m (in 1995 prices) in instalments during the construction of HS1;

- Deferred Grant of £600m (in 1995 prices) in instalments over two years following the completion of HS1;

- Domestic Capacity Charge (DCC) in respect of the right to purchase capacity on the railway for domestic train services. The DCC amounted to £337m (in 1995 prices) payable in semi-annual instalments over 17 years following completion of HS18.

7 The unwind cost is greater than the £179.7m lease liability in the EUKL balance sheet at the end of 2007 since it represents the actual shortfall in the receipt of proceeds due to the prepayment. 8 The DCC results from the fact that the UK Secretary of State for Transport (UKSS) has purchased the right to operate up to 8 train services an hour in each direction for high-speed domestic train services on HS1 to and from destinations in Kent. The detailed entitlement of the UKSS is set out in the Development Agreement and amounts to a maximum of just over 1,000 train services a week. Following a competition held in 2005, the UKSS awarded London and Southeastern Railways (LSER) a franchise to operate these services, potentially until 2014. The terms of the franchise envisage that LSER will operate close to the maximum number of services to which the UKSS is entitled. These domestic services are scheduled to be introduced on HS1 in December 2009. Rolling stock for domestic services should progressively be delivered by the first quarter of 2009 and subsequently commissioned to HS1. Open access operators of domestic services may also apply for access to HS1.

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38. In addition, the UK also gave certain transitional support to LCR’s financing in the development period prior to the start of construction of HS1 which has now ended.

39. Furthermore, LCR undertook to make land rental payments to the Secretary of State from 16 years after financial close (assumed to be 2014) until 2052, amounting to £25m per annum up to a limit of £50m per annum (in 1995 prices indexed to the retail price index).

40. The Commission did not consider this package of supports to be State Aid.

41. Similarly it did not consider as State aid an existing Government guarantee supporting the lease of Ashford International Station by EUKL.

2.3.3. Commission Decision N 576/98 of 18 January 1999 (1999 Decision)

42. In September 1998, the United Kingdom notified to the Commission a first reorganisation of the HS1 project settled between the Secretary of State, LCR, Railtrack and ICRR (the 1998 package).

43. Such reorganisation became necessary following the failure of LCR’s original financial plan for the HS1 project. Indeed, the original financial plan envisaged a flotation/initial public offering coupled with a substantial debt-raising in the bank and bond markets to finance construction along with the payments of Government grant committed in the Development Agreement. This financial plan was based on the assumption that EUKL would reach break even point before LCR’s flotation and subsequently generate cash-flow for the HS1 project during the construction period. However, it became apparent that the initial revenue forecasts for Eurostar could not be achieved and that LCR’s original financial plan could not be implemented.

44. The 1998 package consisted in segregating the risks of Eurostar from the risks of the construction project and assembling risk transfer packages to deal with these two components of LCR.

45. The Eurostar performance risk-sharing was conceived as follows:

- A contract for the management of Eurostar was awarded to ICRR, following a competitive tendering process;

- The risk-sharing was structured around target levels of EUKL’s operating cash-flow in each year based on a central case expectation at the time the terms were agreed;

- ICRR received a management fee based on EUKL revenue and a share of cash-flow achieved above target (gain-share). Against this, ICRR was obliged to contribute to EUKL if cash-flow was below target (pain-share). Both the gain- and pain-share amounts were capped. As a result of actual operating cash-flow under-performing the target, ICRR has contributed a net £[…]*m to EUKL since entering into the contract.

In the event this period runs 2005-2022. The Development Agreement contained a formula on which the Secretary of State for Transport could renew the DCC at the end of the 17 year period.

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- According to the UK authorities, it is expected to contribute just over £[…]*m (net) in each of the remaining years of the contract to 2010.

46. The HS1 risk-sharing was achieved by involving Railtrack the owner and operator of the UK domestic rail network in the project as follows:

- As Railtrack was initially deterred from participating by the size of the project compared with its balance sheet, the delivery of HS1 was phased into the two sections, described in 2.2.1, undertaken by two separate LCR subsidiaries.

- Railtrack agreed to purchase Section 1 following completion at a price based on the outturn cost9.

- In return, Railtrack would receive track access charges from EUKL which, together with DCC payments from Government, were calculated so as to deliver a return on the basis of a target cost10 (£1,929m). The access charges also remunerated Railtrack for operating, maintaining and renewing the infrastructure.

- According to such mechanism, if the project had cost less than the target cost, Railtrack’s return would have increased and vice versa. In this way, construction risk was transferred to Railtrack.

- Furthermore, Railtrack had an option to purchase Section 2 on a similar basis at a price based on a target cost of £3,303m.

47. The 1998 package was supported by a radically different financial plan involving substantial public support, as described below:

- Direct Grant: the grant originally committed to the HS1 project was split between Sections 1 and 2 and re-profiled to take account of the revised timetable for the construction of HS1 in two phases. As a result, the UK government direct support consisted in a capital grant of £555m payable in installments during the construction of Section 1, and a deferred grant of £1,036m payable in installments during the construction of Section 2;

- Government Guaranteed Bonds (GGBs): State guarantee of £3.75bn of medium- to long-term debt issued as bonds by LCR. With the bond proceeds, grant payments and purchase proceeds from the sale of Sections 1 and 2 to Railtrack, LCR was committed to finance the construction of HS1 up to the funding budget limits of £2,245m for Section 1 and £3,905m for Section 211;

- Access Charge Guarantee: State guarantee on the access charges which EUKL would pay to Railtrack for access to the completed Sections of HS1. As a result, Railtrack would not be exposed to the business and credit risk in EUKL. The potential exposure of the UK government under this guarantee was considerable, since it related to

9 Outturn cost = actual cost 10 Target cost = projected cost 11 Railtrack also agreed to guarantee LCR bank facilities of £700m to fund the construction of Section 1, and to fund construction directly if costs went above the funding budget limits

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the overall value of the access charge on HS1 over the (then reduced) length of the LCR concession to 2086;

- Access charge loan facility: public support to EUKL for maintaining the project’s liquidity until sufficient cash-flow was generated to repay debt. This facility could be drawn to fund EUKL’s payment of access charges if they could not be funded from LCR’s other financing resources. Drawings were subject to a number of limitations:

i. a cap each year of the amount of EUKL’s access charges payments;

ii. the facility could only allow EUKL to break even in cash terms;

iii. the facility could only be applied to fund the payment of access charges and provide no other financial benefit;

iv. the facility should be repaid before EUKL (or LCR) can distribute profits.

At the time, the central case expectation of drawings was £184m12.

48. Lastly, the 1998 package provided for certain modifications as far as LCR and its shareholders are concerned:

- Although LCR’s shareholders retained ownership of LCR, 95% of the value of their equity investment in LCR (£70m) was converted into redeemable preference shares with an accumulating dividend of 7% per annum. Redemption was made conditional on completion of Sections 1 and 2 of HS1 in order to incentivise the shareholders to procure timely completion of the phases within the funding budget13;

- Reduction of the duration of the HS1 concession from 999 years to 90 years (i.e. to 2086) so that it would expire in the same year as the Channel Tunnel concession;

- LCR undertaking to pay to the UK government 35% of its operating cash-flow from January 2021, in return for the bond and access charge guarantees. Any such payments were to be applied to reduce the amount of any drawings under the Access Charge Loan Facility and the loan advanced by the UK government to EUKL to terminate the ENS finance leases;

- Re-profiling of land rentals without altering the overall present value of the payments until the end of the concession in 2086. The rental

12 This estimation was expressed as a present value in January 1997 prices using a discount rate of 6% per annum in real terms in view of the long time-frame over which the support provided in the Facility was to be provided. 13 Half the shares were redeemed on the issue of the permit to use of Section 1 in September 2003 and the balance was redeemed on the completion of Section 2 construction in September 2007.

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payments amounted to £55m per annum increasing by £5m per annum up to a limit of £75m per annum14;

- There was no prospect, based on then prevailing date traffic projections, that LCR’s shareholders would receive a return on their ordinary shares.

49. On 18 January 1999, the Commission cleared the measures put forward by the UK government for the 1998 package on the following basis15:

- the net present value of the direct public grant remained the same as that cleared as non-aid by the Commission's 1996 Decision;

- the guarantees of LCR’s bonds (GGBs) and EUKL’s payment of access charges (Access Charge Guarantee) were permissible State Aid under Art 87(3)(b) EC Treaty in that they were necessary to enable the procurement of a project of common European interest. It should be noted that the Commission did not monetise the value of the Access Charge Guarantee;

- the Access Charge Loan Facility amounting to £184m16 was permissible under Art 73 EC Treaty as implemented by Art 3(1)(b) of Council Regulation (EEC) N° 1107/70 of 4 June 1970 on the granting of aid for transport by rail, road and inland waterway17. The Commission took note of the intention of the UK government that the facility would not be drawn until after 2010.

50. In addition, the decision of the Commission covered (i) the compensation to Railtrack for the potential payment of stamp duty arising from the purchase of Sections 1 and 2 of HS1, and (ii) an increase in support given to LCR’s development period financing through a rolling stock lease purchase facility expressly increasing the permitted limit by £120m from £242m to £362m. The Commission also noted that the United Kingdom had stated its intention to require the re-tendering of EUKL management at the end of its term in 2010.

2.3.4. Commission Decision N706/2001 of 24 April 2002 (April 2002 Decision)

51. After Railtrack itself ran into financial difficulties, the UK government was obliged to launch a further reorganisation of the arrangements for the HS1 project in 2001 (the 2001 package). Indeed, Railtrack no longer had financial capacity to purchase Section 2 of HS1 on the terms agreed in 1998, which constrained the UK government to revise the risk-transfer and financing arrangements for the HS1 project.

52. The 2001 package was based on the following arrangements:

- Cost Overrun Protection Programme developed LCR with its shareholder Bechtel. This programme transferred a significant

14 The payments were expressed in January 1997 prices and were indexed to the retail price index. 15 Commission decision of 18 January 1999 No 576/98 – United Kingdom – Channel Tunnel Rail Link. 16 NPV in 1997 prices. 17 OJ L 130, 15.6.1970, p.1

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proportion of the construction risk of the Section 2 project to Bechtel and the insurance market. Railtrack surrendered its option to purchase Section 2 and contracted with LCR to be the operator of the railway;

- in return, LCR and the UK government agreed to assist Railtrack with the purchase of Section 1 by "de-risking" Section 1 access charges paid by EUKL (guaranteed by the UK government) and Section 1 DCC payments (paid by Government). These cashflows were at risk to the availability of the railway: de-risking the access charges and DCC converted them into irrevocable and unconditional payment streams of high credit quality, which could be efficiently securitised by Railtrack to fund the purchase of Section 1;

- since Railtrack would not be purchasing Section 2, LCR needed to extend the maturity of £1.1bn of the £3.75bn of GGBs approved in 1998. LCR planned to issue the bonds with a significantly longer maturity and repay them with the long term cashflows of the HS1 project;

- LCR also planned to refinance its investment in Section 2 in the same way that Railtrack had proposed to finance the purchase of Section 1 i.e. with de-risked Section 2 access charges and DCC;

- The expectations for LCR to raise large cash proceeds from the issue of the GGBs and Railtrack’s purchase of Sections 1 and 2, and also from instalments of Capital and Deferred Grant could therefore not materialise. In order to ensure that LCR achieved the planned levels of return from its cash balances to fund the construction of HS1, LCR decided to hedge its exposure to interest rates with a portfolio of interest rate swaps. The UK government provided a State guarantee LCR’s liabilities under the interest rate swaps;

- The UK government undertook to cover the costs that might arise to the HS1 project as a result of the implementation of Council Directive 96/48/EC of 23 July 1996 on the interoperability of the trans-European high-speed railway system18.

53. The 2001 package measures were notified to the Commission. On 24 April 2002, the Commission decided that the notified aid measures were compatible with the common market by virtue of Article 87(3)(b). Some modifications to the Access Charge Loan Facility were approved under Article 73 as implemented by Article 3 (1) (b) of Regulation 1107/70/EEC.

2.3.5. Commission Decision N523/2002 of 18 September 2002 (September 2002 Decision)

54. Railtrack’s financial standing did not recover and in October 2001 Railtrack was placed in Railway Administration. This caused the second major revision to the financing and risk transfer arrangements for the HS1 project (the 2002 package).

18 OJ L 235, 17.9.1996, p. 6

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55. The 2002 package was based on the following arrangements:

- Acquisition by LCR of Railtrack’s interests in Section 1 for £375m;

- LCR then on-sold the operator contract to Network Rail (Railtrack plc’s successor) for £80m with its scope enlarged to cover the operation of Section 1;

- As a result, the overall project shape designed in 1998 left in place but, instead of Railtrack owning and operating HS1, LCR through its subsidiaries would own the HS1 infrastructure and Network Rail would be its operator;

- LCR planned to use itself the de-risking arrangements previously agreed with Railtrack and the UK government to securitise the Section 1 DCC and the access charge cashflows paid by EUKL for access to Section 1;

- the UK government agreed to further changes to the conditions of payment of Deferred Grant instalments payable in respect of Section 2, according to which they would be paid unconditionally on the due dates and could also, be applied to secure existing financing of Section 1 and for additional financing needs.

56. The 2002 package measures were also notified to the Commission. On 18 September 2002, the Commission decided that changing the identity of the beneficiary of the State aid (from Railtrack to LCR) did not alter its assessment. The Commission therefore concluded that the notified aid measures were compatible with the common market by virtue of Article 87(3)(b).

2.3.6. Commission Decision N687/2002 of 30 April 2003 (2003 Decision)

57. As funding proceeds were progressively applied to the construction of HS1, LCR became unable to provide cash collateral as a guarantee to swap counter-parties. The Secretary of State therefore agreed to guarantee LCR’s obligations to interest rate swap counter-parties in two sets of hedging arrangements designed to hedge the interest cost of future bond issuance by LCR. The two sets of hedging arrangements were:

- ‘New hedging arrangements’ in respect of a securitisation of de-risked Section 1 EUKL access charges and Section 1 DCC19;

- ‘Further hedging arrangements’ in respect of raising additional debt for the refinancing of the funding of the construction of Section 2, potentially through a securitisation of the track access charges and DCC in respect of Section 220.

58. These hedging arrangements were notified to the Commission on 22 October 2002. The Commission decided in the 2003 Decision that the hedging arrangements were consistent with and preserved the overall public financial

19 Following construction of HS1, these hedging arrangements are being substantially unwound. 20 To date there has been no securitisation in relation to Section 2.

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package in favour of the HS1 project which had already been approved by the Commission on the basis of Art 87(3)(b) of the EC Treaty.

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2.3.7. Summary of the financial support already approved as State aid

Support previously approved as State aid (as restated by the UK authorities)

Items Amounts £m

Amounts €m

Notes

GGBs 3,750 4,688 NPV of the maximum exposure under the guarantee, i.e. the total debt principal

Section 1 Access Charge Guarantee

1,80021 2,250 NPV of the Section 1 Track Access Charges (being the maximum exposure under the guarantee), using the average cost of debt for the Section 1 securitisation

Section 2 Access Charge Guarantee

2,50022 3,125 As for Section 1 guarantee, but based on debt which could be raised against Section 2, subject to prevailing interest rates and market conditions

Access Charge Loan Facility 550 688 Based on £184m NPV in 6% real 1997 terms, restated in 3.5% real 2009 terms

Net out Access Charge Loan Facility

(550) (688) The Access Charge Loan Facility mitigates exposure under the Access Charge Guarantee, so is not additive

Rolling stock guarantee 120 150 Permissible increase in overall level of rolling stock guarantees from £242m to £362m (in 1998 restructuring)

Eurostar rolling stock guarantee 183 229 Based on estimate of buyout cost

ENS rolling stock guarantee 110 138 Based on liability in EUKL accounts

Stamp duty relief 120 150 NPV 1997. Intended for Railtrack but may be needed for HS1 purchaser

Hedging guarantees 48 60 £13m + £5m + £30m nominal

Total support previously approved as aid

8,631 10,790

21 It must be noted that the Access Charge Guarantee was not monetised in the Commission's decision approving the Access charge Guarantees for Sections 1 and 2. However, for the purpose of the calculation regarding the present operation, the UK authorities have based this value on the level of debt which could be raised in reliance on the ACG. Since the section 1 securitisation has already taken place, the value is known. 22 Idem. However, since no section 2 securitisation has been undertaken, the UK authorities have prepared an estimate on a similar basisi and assuming market conditions.

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2.4. London & Continental Railways' current situation 59. Following the various changes introduced over the years and the application

of the relevant State aid decisions, the below diagram describes the current structure of LCR23.

2.4.1. LCR‘s financial situation

60. As far as the financial situation is concerned, LCR indebtedness is summarized in the table below.

LCR’s debt as at 31 December, 2007

Debt instrument Security Liability as at end 2007, £m

When incurred

Rolling stock finance leases – EUKL Government guarantee 180 1994

ENS loan – EUKL Government counter-indemnity 110 1994-1998

Ashford International Station lease - EUKL Government guarantee 47 1994

337

4.75% bonds due 2010 (GGB) Government Guarantee 1,000 1999

4.5% bonds due 2028 (GGB) Government Guarantee 1,225 1999

4.5% bonds 2038 (GGB) Government Guarantee 425 1999

Secured bank loan (EIB) De-risked access charges 200 1999

Secured bank loan (KfW) De-risked access charges and cash 100 1999

2,950

Total before March 2001 3,287

23 Section 1 linked the Channel Tunnel to North Kent and Section 2 completed the railway to St Pancras International via new stations at Ebbsfleet and Stratford.

Sections 1 and 2 also receive DCC

payments from Government

CTRL (UK) Limited owner of HS1 Section 1

Union Railways (North) Limited owner of HS1 Section 2

Eurostar (UK) Limited (EUKL)

Section 2 track and station access charges

Residual Section 1 track access charges

HS1 operation sub-contracted to Network Rail

Section 1 track access charges, largely hived off to support

Section 1 securitisation

Property development

interests

17

5.10% bonds due 2051 (GGB) Government Guarantee 1,100 2002

5.234% asset-backed bonds due 2035 De-risked access charges 748 2003

2.334% index-linked asset-backed bonds due 2051

De-risked access charges 571 2003

Secured bank loans (EIB) De-risked access charges 400 2003

Secured bank loans (KfW) De-risked access charges and cash 150 2003

Total after March 2001 2,969

Total 6,256

61. According to the UK authorities, forecasts for LCR’s debt at 31 December 2008 amount to £ 6,268m.

62. The overall financial reorganisation and restructuring of LCR is justified by this high level of indebtedness and related low equity, the need to prepare the opening of the market and foster competition but also the intention to reduce the UK government financial exposure.

63. The table below shows LCR's consolidated balance sheet at 31 December 2008 and a pro-forma for the same balance sheet following the operation described in section 3.

LCR consolidated balance sheet As at 31 December 2008

As audited at 31/12/08

£'m Fixed assets: HS1 related assets * 5,991.5 * Other fixed assets incl' intangibles 602.1 Current assets: Cash & investments 207.8 Cash into Eurostar - Other current assets 196.8 Creditors: Government G'teed Bonds (3,726.0) Securitised Bonds (1,339.3) Finance leases (361.3) ENS loan from Sec of State (109.8) Government grants being amortised * (3,192.5) * Bank debt -EIB/KfW (842.9) Other creditors (462.5) Provisions for liabilities & charges (58.5) (Deficit) / Surplus in equity shareholders' funds (3,094.6) Owned by: LCR shareholders * HS1 fixed assets should be considered net of Government grants, though are reflected gross for Annual Accounts purposes. On the revised concession terms, the net value of HS1 assets is expected to fall to approximately £[…]*. Pro-forma asset and grant figures are indicative.

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2.4.2. EUKL’s financial situation

64. The table below sets out the key elements of EUKL’s balance sheet as at 31 December 2007 (and a forecast for 2008). According to the UK authorities, EUKL had a deficit in equity shareholder’s funds of £1.73bn.

EUKL consolidated balance sheet as at 31 December: (£m)

2007 2008

Audited £m Forecast £m

Fixed assets 58.0 68.0

Current assets

- cash 5.8 5.0

- other current assets 109.3 110.0

Total current assets 115.1 115.0

Creditors

- intercompany liability to LCR

(1,438.5) (1,638.9)

- finance leases (226.4) (221.0)

- ENS loan from Secretary of State

(109.8) (109.8)

- other creditors (83.4) (64.7)

Total creditors (1,858.1) (2,034.4)

Provisions for liabilities and charges

(45.6) (9.6)

Total net liabilities (1,730.6) (1,861.0)

Deficit in equity shareholder’s funds

(1,730.6) (1,861.0)

65. According the UK authorities forecasts, EUKL’s deficit in shareholder funds is expected to increase to £1.86bn and the inter-company liability to LCR is expected to increase to £1.64bn, by 31 December 2008. Such degradation is driven by the unaffordable cost of access to infrastructure.

66. EUKL has registered share capital of £701 million, and had an operating loss deficit of £2,578 million at 31 December 2008. EUKL's trading losses (i.e. capital movements) in the 12 months to 31 March 2009 were some £190 million24.

3. DESCRIPTION OF THE OPERATION

3.1. Rationale of the operation

67. The United Kingdom intends to establish each of LCR's businesses on a sustainable commercial and financial basis, with conventional ownership and

24 This loss comprises EUKL's first quarter's losses of 2009, 3/4 of its 2008 losses, and EUKL's estimated share of the pension deficit arising in 2008.

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debt structures. The present operation is driven by the following objectives for the United Kingdom:

- to implement a structure for LCR which suits the long-term operating and financing needs of its component businesses (infrastructure with HS1 Co; train operations with EUKL and property);

- to escape a range of long-term guarantees and liabilities which the UK government has provided LCR and its businesses;

- to remove the need for ongoing public sector support for those businesses;

- and to maximise utilisation of HS1 and in particular to encourage competition for international services, taking advantage of the introduction of the third railway package in 2010.

68. The United Kingdom proposes to achieve these objectives by:

- separating LCR into its component businesses;

- assuming LCR’s debt;

- crystallising existing guarantees;

- restructuring EUKL by providing a one-off capital injection to put it on an equal footing with potential competitors.

69. The operation at stake should materially reduce the overall level of public sector support for LCR, mainly through the recast and the removal of pre-existing aid approved by the Commission. In addition, the cost of these measures will be offset by proceeds from the sale of LCR businesses (HS1 Co, property development and EUKL).

70. Indeed, the operation consists in the following measures involving support from the UK government:

- the UK Government will assume all of LCR’s Government-guaranteed or Government-supported debt;

- the existing Government guarantees will crystallise25 through the prepayment of rolling stock finance leases and the prepayment of the Ashford International Station lease;

- LCR’s businesses will be separately capitalised on an independent and financially sustainable basis with conventional debt and equity, and without a Government guarantee of LCR’s debt or of EUKL’s access charge obligations.

71. In return, the UK government foresees the following measures :

- the three businesses will in due course be sold or otherwise divested to achieve the separation of LCR into its component businesses and to achieve appropriate commercial incentives and risk transfer;

25 In the present decision, crystallisation means the removal of a State guarantee and the conversion of the corresponding liabilities into grants.

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- all the sale proceeds and profits of LCR’s businesses would be remitted to the UK Government;

- the concession period for HS1 which currently extends to 2086 will be significantly shortened to around 35 to 40 years from the completion of the sale of HS1 and land rental payment will be terminated;

- LCR’s shareholders will not receive a return from the sale of LCR’s businesses;

- LCR will in due course be wound up.

72. In addition, the reorganisation will also involve major revisions of the current access arrangements for HS1, leading to a reduction of access charges. Access charges will be established at a level which the United Kingdom believes should support the evolution of a competitive market for cross-channel rail passenger services while at the same time providing for the recovery of a substantial portion of the costs of developing the new line.

73. Furthermore, the UK authorities have committed that, irrespective of the legal basis used for its approval, the operation would be subject to the "one time, last time principle" and that therefore no restructuring aid in the sense of the Rescue and Restructuring Guidelines would be granted to LCR.

74. The operation is articulated around the seven following steps, which contain a detailed description of the corresponding measures.

3.2. Step 1 - consolidation of Sections 1 and 2 of HS1 into HS1 Co

75. The first step of the reorganisation plan consists in completing the consolidation of Sections 1 and 2 of HS1 into one LCR subsidiary HS1 Co.

76. NR (CTRL) will then issue for industry consultation a formal Network Statement on behalf of HS1 Co containing the access charging proposals. Subject to the results of the consultation process, the reduced access charges for HS1 will then be ready for implementation through new HS1 access agreements.

77. The benefits related to the single management of the HS1 construction project no longer exist now that the railway is completed. Therefore, the UK Government and LCR came to the conclusion that LCR would achieve more value for and better management of its businesses if they were separated rather than if they were managed as one group.

78. The separation of LCR’s businesses involves the transfer of certain property assets in HS1 and developing new arm’s length commercial relationships between EUKL and HS1 Co.

79. On the one hand, it concerns the lease of Ashford International Station, currently held by EUKL. This lease is supported by an existing Government guarantee (see section 2.3.2 above). £[…]*m will be applied from the government for the prepayment of this lease and the lease will be novated to HS1. EUKL will then contract for access to Ashford International Station on an open access basis.

80. On the other hand, the consolidation of property assets in HS1 regards the newly built train depot at Temple Mills, near Stratford, for the repair and

21

maintenance of Eurostar train sets. This depot was constructed by LCR’s subsidiary URN at a cost of £360m (including land acquisition costs) and completed in April 2007. Almost all of the costs of land acquisition and construction of the Temple Mills depot were financed by public financing in accordance with the Development Agreement.

81. The depot which is now owned by URN as part of the HS1 Section 2 asset will be transferred to HS1 Co and then leased to EUKL on arm’s length terms26. EUKL would continue to bear the costs of operating and maintaining the depot as it does now. In addition, HS1 Co will make available sidings at Temple Mills for the stabling of domestic train sets during the day and EUKL will be obliged to provide depot services to third parties on non-discriminatory terms.

82. These arrangements […]* within the scope of the change mechanisms provided by the Development agreement, which in itself did not involve any element of State Aid (see Section 2.3.2 above). The UK authorities stress that the Government extracted significant public benefit through these mechanisms in similar projects (i.e. transfer by EUKL to the Secretary of State of Waterloo International Terminal and the North Pole depot, as well as the release of the capacity on the North London Line for the development of domestic services on orbital London routes).

3.3. Step 2 - LCR debt relief

83. As a second step of the restructuring, the UK government will assume all of LCR’s Government-guaranteed bond and bank debt as set out in the table in Section 2.4.

84. LCR also funds EUKL to enable it to arrange: (1) prepayment of its Eurostar rolling stock leases (Government guarantees of any residual liabilities under these leases remain in place during the run-off periods); (2) prepayment of the Government guaranteed lease for Ashford International Station. The Access Charge Guarantee is rescinded, there would be no further de-risking of EUKL access charges or the DCC (as described in detail in section 3.5). Finally the Secretary of State cancels EUKL’s liability to Government in respect of the ENS rolling stock lease termination.

85. The effect of this step is to convert some £6.3bn of bond and bank debt and leasing liabilities which are currently guaranteed or otherwise supported by the UK government into government grant to LCR through the relief of its debt27.

* read: "have happened" 26 The lease payments have been structured to recover approximately £8m of otherwise unrecovered costs of construction of the Temple Mills depot. 27 HS1 will be sold with a financing package in place which may incorporate up to £850m of bank debt (EIB/KfW) within the £6.3bn total if the banks are prepared to exchange the UK government support of their debt with a revised security package which does not involve a government guarantee. However, while the security package for the facility is renegotiated, the bank will retain their current security i.e. de-risked DCC and Government-guaranteed access charges. This means that these mechanisms will continue beyond the assumption of LCR's debt by the UK government and the implementation of the revised access arrangements. The UK authorities specified their alternative at the point of the sale: if bidders did not choose to make use of such facility, they will assume this debt and DCC payments will be discontinued. Should the successful bidder chose to take on the EIB/KfW

22

86. At the same time that the UK government assumes LCR’s debt obligations, it will purchase LCR for a nominal sum directly from its existing shareholders. However, the UK authorities indicate that such purchase of LCR by the UK government will not make any practical difference to the constitution of the LCR board, the governance and the working arrangements within the company. The LCR board will retain its existing arm's-length relationship with the UK government and would have independence of deliberation.

87. The table below shows a pro-forma for LCR's consolidated balance sheet following the operation described in the present section.

facility, it would become responsible for providing any necessary security package for servicing the loan and DCC payments would be also discontinued.

LCR consolidated balance sheet Pro-forma

As at 31 December 2008 Restructure

d at 31/12/08 £'m Fixed assets: HS1 related assets * 3,500.0 * Other fixed assets incl' intangibles 336.0 Current assets: Cash & investments 207.8 Cash into Eurostar […]* Other current assets 196.8 Creditors: Government G'teed Bonds 0.0 Securitised Bonds 0.0 Finance leases (132.3) ENS loan from Sec of State 0.0 Government grants being amortised * […]* * Bank debt -EIB/KfW (842.9) Other creditors (412.5) Provisions for liabilities & charges (58.5) (Deficit) / Surplus in equity shareholders' funds […]* Owned by:

HM Government

* HS1 fixed assets should be considered net of Government grants, though are reflected gross for Annual Accounts purposes. On the revised concession terms, the net value of HS1 assets is expected to fall to approximately £[…]*. Pro-forma asset and grant figures are indicative.

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3.4. Step 3 - implementation of revised access arrangements

88. As indicated in section 2.3.3, EUKL entered into access arrangements (track access to section 1 of HS1; track and station access to section 2 of HS1 and the international station at Ebbsfleet, Stratford and St Pancras) for the HS1 in the 1998 package. The UK government has also purchased the right to operate services for high speed domestic trains on HS1. However, since 1998, there have been significant developments in EU rail policy which lead the UK government to design new access arrangements.

89. The proposed new access charging framework and charging regime for HS1 is subject to the following general principles:

- Access charges for HS1 should be largely usage-dependent (with operators paying for timetabled capacity);

- They should allow for the recovery of the unrecovered costs of construction of HS1 (in compliance with the exception to the principle of cost-reflective charging in the 2005 Rail Regulations that applies to specific investment projects completed since March 1988);

- This investment recovery element of the access charge should be reset so that the investment recovery charges paid for domestic and international train services bear a reasonable relationship to each other after adjusting for distance travelled on the railway and train speeds ("normalised investment recovery charging");

- The investment recovery charges should then be fairly apportioned between different users of the railway and not solely allocated to EUKL through track access agreements, and to the UK government (through the DCC arrangements);

- Access charges should be set at such a level that: (1) in the course of time, EUKL does not need special support in order to be able to pay the charges; and (2) there is a reasonable expectation that new entrants will be able to afford access to the railway;

- The DCC will be cancelled, which represents a reduction in the existing commitments of the UK Government to LCR as part of its financial re-organisation

90. According to the UK authorities, the charging regime has also been designed to facilitate the use of HS1 as a high-speed railway by existing users and new entrants and to take into account the end-users of the railway, principally passengers. As a result, it has entailed a substantial reduction i) in the investment recovery charge for international passenger services and ii) in the debt-bearing capacity of LCR’s HS1 business and its equity value after debt service.

91. The UK authorities underlined that this new access charging system is pivotal to the wider reorganisation and to the Commission's approval of the State aid implications. In addition, the UK authorities indicated that these principles and levels of investment recovery charge have been subject to a consultation process.

24

92. According to the UK authorities, the current investment recovery charge profile can be summarised in the table below:

Investment

recovery charge p.a.

Number of services p.a.

Implied investment recovery per train service

Domestic Capacity Charge28

£90m 56,250 £1,600

EUKL HS1 access agreements

£175m 16,000 £10,937

93. The proposed access charges for principal passenger services from St. Pancras to the Channel Tunnel and to the junctions with the domestic UK rail network at Ashford and Ebbsfleet would be as follows:

HS1 – proposed investment recovery charges

Type of passenger service Max speed (2007 prices)

International passenger service (St. Pancras to the Channel Tunnel)

300kph £2,150

Domestic passenger service (St. Pancras to Ashford) 230kph £2,100

Domestic passenger service (St. Pancras to Ebbsfleet)

230kph £1,000

94. In addition, the UK authorities intend to modify the charging system for OMR (operation maintenance and renewal). NR (CTRL) currently manages the OMR of HS1 and is reimbursed its costs for so doing, together with fees and performance incentives. These costs and fees are passed on to HS1 users.

95. According to the new system, train operator would be charged direct costs such as traction current and an equitable proportion of the common OMR costs for HS1 track and station infrastructure which includes both NR(CTRL)’s costs and HS1’s own costs. The UK authorities indicated however that precise basis of apportionment will be subject to consultation with the industry.

96. However, the UK government considers that OMR costs are artificially inflated by a legacy finance cost born by NR(CTRL) resulting from the debt service costs of the UK government loan to Network Rail to purchase Railtrack's business, as presented in Section 2.3.5. As a consequence, the UK government will buy out this loan in order to ensure that all future users of HS1 bear only the economic costs of their usage29.

97. In this context, the third step includes four sub-measures which can be summarised as follows:

- the new HS1 access agreements between HS1 Co and the train operators wishing to use HS1, including EUKL and domestic franchisee LSER will

28 Thus, the DCC represents a contribution towards investment recovery for a given level and configuration of passenger train services operating on HS1 at particular speeds, and therefore allows for an implied charge for the use of the railway to be calculated 29 The cost of this measure is estimated to £[…]* as described in table 3.9.

25

become effective, adopting such normalised investment recovery charging;

- the loan to NR (CTRL) funding the purchase of HS1 and St Pancras operations will be bought out.

- HS1 Co will also enter into a lease of the Temple Mills depot to EUKL;

- the cancellation of the DCC by the UK government and the adoption of alternative structures for the provision of domestic rail services after the current franchise with LSER expires in 2014;

- transitional OMR cost shortfall bridge: there will be a transitional period from the time of reorganisation and introduction of the revised access charge regime until the end of 2009, during which EUKL will remain the sole operator on HS1. According to the UK authorities, this would unreasonably expose EUKL to full OMR costs for this period which it may challenge as inequitable. Therefore they intend to bridge this transitional exposure by paying the domestic apportionment of OMR charges from the point of reorganisation to the commencement of domestic services in December 2009 (up to £50m).

98. Finally, the UK authorities specify that an analysis conducted by traffic consultants Oliver Wyman showed that an investment recovery charge at around the levels shown in the above table together with an equitable apportionment of OMR (operation, maintenance and renewal) costs would be affordable to open access operators of international passenger train services.

3.5. Step 4 - EUKL Recapitalisation and cancellation of the Access Charge Loan Facility

99. The fourth step is the recapitalisation of EUKL, when the new HS1 access agreements will become effective. Indeed, the UK authorities consider that EUKL as currently capitalised and with its existing level of HS1 access charges is not a viable entity without State subsidy. In their view, the failure of EUKL could result in failure of a cross-channel rail market before it has had an opportunity to establish and mature, and would inhibit or delay market liberalisation through open access operation.

100. According to the UK authorities, a rational investor, saddled with current liabilities, may need to make short term expenditure to achieve long term gains. That is what is happening here. If EUKL legacy costs were not met, Eurostar would be incapable of competing, the restructuring would no longer be feasible since there would no longer be a resilient HS1 market and so the value on sale would no longer sustain the preferred model.

101. The UK authorities are of the opinion that such hypothesis would result in the perpetuation of the current model which is no longer apt and of a subsidy structure that could not be modified and minimised.

102. With the recapitalisation of EUKL, the UK government pursues the following sub-objectives:

26

- to ensure that EUKL is a financially sustainable entity in its own right and will not require on-going financial support either from LCR or from the UK government (through the Access Charge Loan Facility);

- to separate LCR’s train operations (EUKL) and HS1 track and station infrastructure businesses and to adopt an access charging regime where there is no investment recovery charge for use of HS1 stations in order to support the business case for utilisation of the stations by train operators;

- to ensure that EUKL and Eurostar are configured in the most effective way for further development of the Eurostar service following the introduction of open access under the Third Rail Package;

- to see the genuine prospect of competition in the provision of international rail passenger services. The new access charging regime should incentivise the new owner of HS1 to promote competition, without precipitating a financial failure of EUKL and instability in the cross-channel rail industry30.

103. The fourth step – recapitalisation of EUKL – includes the three following sub-measures:

- the restructuring of EUKL’s balance sheet to reflect the wider financial reorganisation of LCR and the associated reduction and reapportionment of access charges. This also involves cancelling some legacy debts and inter-company liabilities and the transfer of assets more properly associated with railway infrastructure rather than train operations;

- the recapitalisation to provide EUKL with sufficient balances to enable it to trade in a reasonable range of ‘downside’ scenarios;

- the support to EUKL either for purchasing new trains or replacing its existing trains on life-expiry without suffering an uncompetitive operating cost disadvantage in the meantime.

104. In return for this support, the UK government will cancel both the Access Charge Guarantee31 and the Access Charge Loan Facility currently provided to EUKL32. The present operation will result in the removal of these mechanisms, enabling the UK to escape long term guarantees and liabilities provided to LCR and EUKL.

3.5.1. Restructuring of EUKL balance sheet

105. EUKL balance sheets for 2007 and 2008 are presented in section 2.4.2. The objective of the UK authorities through this restructuring consists in reaching a more sustainable financial situation for EUKL, which balance sheet should be as follows:

30 In this regard, the UK authorities underline that any prospect of failure of the incumbent payer of access charges for international passenger rail services would be regarded very negatively by potential purchasers of HS1 and, in the short to medium term at least, could affect the viability of a wider cross-channel rail market. 31 The UK authorities have indicated the sole exception of the financial arrangements regarding EIB/KfW debt as described in details in footnote 27. 32 EUKL currently has a facility size of £550m

27

EUKL pro forma consolidated balance sheet as at 31 December 2008 following its restructuring and recapitalisation (£m) Fixed assets33 48.0 Current assets - cash […]* - other current assets 110.0 Total current assets […]* Creditors - finance leases - - intercompany liability to LCR - - ENS loan from Secretary of State - - other creditors (64.7) Total creditors (64.7) Provisions for liabilities and charges (9.6) Total net assets […]* Equity shareholder’s funds […]*

106. This sustainable financial situation would be reached following the adoption of the following sub-measures

- Cancellation of inter-company liability to LCR: LCR has funded EUKL’s trading deficits since its acquisition of EUKL in 1996 by means of an inter-company loan. This loan amounted to £1.44bn at 31 December 2007 and is forecast to rise to c.£1.64bn by 31 December 2008 due to high access charges paid by EUKL, leading to substantial increases in EUKL’s annual operating loss. This loan has been funded out of LCR’s existing resources including the issue of GGBs34. At the time the UK government assumes LCR’s debt, the UK authorities consider that this related inter-company loan should also be cancelled;

- Novation of EUKL finance lease for Ashford International Station to HS1 Limited and prepayment (as described in Section 3.2.): EUKL will continue to act as station operator of Ashford International Station and any train operator seeking access to the station will be able to apply for access under conventional station access agreements and in compliance with the UK legislation. Prepayment of the lease (estimated at £[…]*) will allow HS1 not to charge an investment recovery charge for the use of Ashford, thus promoting the business case for utilisation of the station by all operators;

- Cancellation of Government loan to EUKL for the purpose of terminating ENS rolling stock leases: The purpose of this sub-measure is to remove EUKL's liability to the UK government for this loan (estimated to £110m)

33 Reduction in fixed assets reflects novation of Ashford station lease to HS1 Co. 34 The 1999 Decision recognised that “… before 2010, LCR can fund EUKL losses using its reserves of Government backed debt.” (Section 4.2)

28

in order to provide EUKL with a capital structure which is free of legacy liabilities to assist EUKL's transition to a competitive international rail market. The cancellation of this loan also forms part of the overall removal of £6.3bn of Government-guaranteed or Government-supported debt from LCR.

- Prepayment of EUKL Eurostar rolling stock leases: The purpose of this sub-measure is to remove from EUKL the liability relating to seven of its eleven Eurostar train sets which were funded through finance leases and guaranteed by the UK government. The cost of the prepayment is estimated at £183m.

- The UK authorities underline that the crystallisation of these guarantees and loan are part of the overall removal of £6.3bn of Government-guaranteed or Government supported debt from LCR35.

3.5.2. Recapitalisation of EUKL and fleet replacement

107. EUKL will receive new funding from LCR in a further subscription of ordinary equity of £[…]* being the EUKL Recapitalisation.

108. In order to assure that EUKL is properly sustainable without further future support (i.e. that all aid genuinely is “one time, last time”), the UK government indeed wishes to assure itself that EUKL has sufficient capital balances to enable the business to trade adequately in a range of downside market conditions; and a credible strategy to meet the investment requirements of the business including the replacement of rolling stock. These are also essential elements in enabling EUKL to compete on level terms with any new entrant.

109. In particular, the UK authorities consider that a new entrant to the market is likely to receive a significant equity injection from its shareholder or shareholders, either in the form of a transfer of assets (e.g. a train fleet) or cash to fund the equity portion of the purchase of such a fleet.

110. Therefore, the UK authorities envisaged different possibilities to implement the recapitalisation and fleet replacement. As a result of a comparison of these possibilities, the UK authorities opted for enabling EUKL to escape the financing costs of running the existing rolling stock by pre-paying the existing leases. This would enable EUKL to build up sufficient capital reserves to fund the purchase of replacement rolling stock when there is a satisfactory business case.

111. In addition, the UK authorities will fund EUKL (in the form of a one-off cash provision) to provide an initial cash balance designed to offset the cost advantage that other operators might achieve from operating more efficient rolling stock from the beginning of their service, whilst EUKL manages its

35 Novation of EUKL finance lease for Ashford International Station to HS1 Limited and prepayment; cancellation of Government loan to EUKL for the purpose of terminating ENS rolling stock leases; prepayment of EUKL Eurostar rolling stock leases.

29

older rolling stock through to life-expiry. This should place EUKL and any new entrant in a broadly comparable position in terms of rolling stock36.

112. According to the UK authorities, this option is preferable as it can be done in a "one time, last time" way co-terminous with the rest of the reorganisation and would not involve any future liabilities. This will provide working capital and offset the difference in operating costs between the rolling stock with which EUKL will be vested, and the more modern rolling stock likely to be used by competitors.

113. In fact the UK authorities argue that the Eurostar train sets are an early generation of high-speed train sets with a large number of bespoke features which had to be designed with specific adaptations to enable operation on the UK domestic network (gauge requirements; three different signalling and electrification systems; specific features stipulated in the early 1990s for operation in the Channel Tunnel). However, new entrants will not be constrained by previous UK domestic requirements as the new HS1 infrastructure is interoperable.

114. In addition, the UK authorities claim that the age and complexity of the current train sets means that Eurostar operates with a sub-optimal fleet size and suffers from low utilisation, poor reliability and high maintenance costs37.

115. The UK authorities requested a consultant, Oliver Wyman, to carry out a study and provide a comparison of the costs of maintaining Eurostar sets against SNCF TGV sets (both current ones and most recent AGVs). The results are presented on the below table:

Eurostar TGV Réseau AGV Refurbished Eurostar

Cost per train mile (£) £[…]* £[…]* £[…]* £[…]*

Seats per train […]* […]* […]* […]*

Cost per available seat mile

[…]*p […]*p […]*p […]*p

Source Eurostar; Oliver Wyman analyses

36 EUKL is expected to replace its fleet in 10 to 15 years’ time and the new entrant would be equipped with a new fleet when it enters the market, with both operators enjoying a comparable underlying cost base in the meantime. 37 According to the UK authorities, on average, Eurostar sets operate approximately […]*route km per annum whereas SNCF TGV sets operate an average of […]*to […]*route km per annum. Eurostar sets develop operational faults requiring trains to be taken out of service at a rate of […]* incidents per million km. Recent SNCF TGV sets develop faults at a rate of […]* incidents per million km and the latest AGV sets being tested by Alstom have a target fault rate of […]*incidents per million km.

30

116. The UK authorities calculated a value for the train maintenance cost differential with the TGV trains over the period 2009-2021, leading to an amount of £[…]*38. The level of EUKL Recapitalisation funding has therefore been approximated to £[…]*.

117. The UK authorities also underline the fact that such support does not cover all cost advantages that may incur possible new entrants. Indeed, it does not allow for the utilisation improvements which also result and which may allow a competitor to deploy a smaller fleet size to achieve the same level of timetable coverage as EUKL’s 11 Eurostar sets. Thus, the restructuring funding leaves EUKL with an incentive to continue to improve its own fleet reliability and utilisation to keep pace with the competition

3.5.3. Cancellation of the Access Charge Guarantee and Access Charge Loan Facility

118. In return for the support to EUKL, the UK authorities intend to couple the restructuring of EUKL’s balance sheet with the cancellation of the Access Charge Loan Facility (£550m) and termination of the Government guarantee of EUKL’s access charge payments.

119. For designing these restructuring measures, the UK government has modelled the future performance of EUKL against a range of scenarios. In fact, such modelling, under the new access arrangements (post-HS1 reorganisation) with competition and with the full amount of restructuring support proposed, has been done against the three separate scenarios below and compared to the profitability of other operators in the transport sector:

- “EUKL High Case” scenario (with positive economic climate and competition);

- “Central Case” or 50:50 scenario (with neutral economic climate and competition);

- “Downside Case” scenario (a negative economic climate with competition).

120. According to the UK authorities, the results of the study which are presented in the notification show that measures for the restructured balance sheet are sufficient, but no more than the minimum necessary, to allow EUKL to continue trading in downside trading scenarios with competition. The proposed package of aid would strike the right balance between providing EUKL with the opportunity for a financial return comparable to other European transport operators39, whilst ensuring that – even in downside scenarios – the means exist to sustain the business.

38 EUKL's existing fleet is approaching mid-life and lease payments legally contracted to 2021. 39 The comparative analysis of the consultant leads to the following result: the forecast EBITDA of EUKL would be […]*% (high case) and […]*% (central case) which is in the same range or even lower than other European transport operators such as British Airways (17,9%), Deutsche Bahn (14%), Easy Jet (11,5%), Stagecoach (7,9%), First Group (7,7%), National Express (5,2%) or Arriva (3,3%).

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121. On the basis of these forecast scenarios, the consultant Oliver Wyman has modelled EUKL’s future performance and calculated EUKL's Earnings Before Interest, Tax Depreciation and Amortisation (EBITDA) until 2030 .

122. Each of the modelled scenarios assumes an identical fleet strategy for EUKL of refurbishment at mid-life […]*and replacement at end-life […]*. Each scenario also assumes competition is introduced into the market from […]*. The principal difference between the scenarios therefore relates to EUKL’s forecast Compound Annual Growth Rate (CAGR) of revenue set out in the below table.

CAGR Downside Central High

2009-2022 […]* […]* […]*

2022 onwards […]* […]* […]*

123. The analysis shows that in three competitive scenarios (“EUKL High Case”, “Downside Case”, “Central Case”), the restructuring measures would allow EUKL to rapidly improve its financial performance. EUKL would become profitable as from […]* in the “High Case" and the “Central Case”. In the “Downside Case”, EUKL would break even in […]*.

124. In 2012, this analysis shows the following level of EBITDA for EUKL: […]* in the “Downside Case”, […]*in the “Central Case” and […]*in the “High Case". The analysis foresees certain fluctuations in EBITDA in the period from […]*relating to the introduction of a competing operator and the impact on EUKL, and between […]* to […]* are due to the replacement of its rolling stock fleet.

125. The UK authorities have provided an indicative agenda for the implementation of the operation. As regards the restructuring of EUKL, the UK authorities expect that the restructuring plan will be implemented as soon as possible after the Commission's approval […]*.

3.6. Step 5 - Sale of HS1 Co

126. The fifth step consists in the sale by LCR of HS1 Co in a fair and open competitive process.

127. The sales proceeds have been estimated to £[…]*. This amount was calculated by the UK authorities by detailed operating and financial modelling built for the sole purpose of the operation. As regards HS1 Co, it was based on the conclusions of the consultant Oliver Wyman study “Traffic and Revenue Forecast for Eurostar and HS1”. The UK authorities have indicated that this estimate is dependant on market conditions.

128. […]*. Likely bidders are expected to be infrastructure investors or railway infrastructure providers. HS1’s revenue sources will be primarily the access

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charge revenue from open access international users, from domestic franchise use and from any open access domestic use which emerges. The confidence of bidders in this revenue stream will inform bidder pricing.

129. The business may be sold with the benefit of debt financing which the successful purchaser may retain or replace with its own preferred financing.

3.7. Step 6 - Transfer of the proceeds of sale of HS1 and all other cash generated in LCR to the UK government (Secretary of State)

130. As a sixth step, LCR will remit to the UK government all cash proceeds from the sale of HS1, less any amounts required to fund the recapitalisation of EUKL and other restructuring costs (with reserve to shares assumptions as mentioned in section 3.3).

131. Over time, LCR will remit to the UK government all cash proceeds from the realisation of value in its property development interests and any proceeds from the sale of LCR’s stake in Eurostar (as described in section 3.8).

132. As a result, the UK government will receive all the proceeds from the sale and realisation of value in LCR’s businesses, which has been conservatively valued at £[…]*but which is highly dependent on market conditions. Following this process, LCR will be wound up.

3.8. Step 7 - Incorporation of Eurostar

133. In parallel with the previous steps, LCR will try and complete the incorporation of the Eurostar service, currently operated as an unincorporated international railway grouping. The terms of the incorporation will not be known until late in the process. The overall timing of this step also depends on LCR’s partners in Eurostar.

134. An effect of this step is that LCR (and potentially the UK government) will acquire an equity stake in the incorporated Eurostar business which in due course it may sell. It is also possible that the UK government may wish to take a larger stake in the incorporated Eurostar business than is implied by the value of the contribution of EUKL. It remains open to the UK government to subscribe in cash for such a stake in addition to the contribution in kind of EUKL.

3.9. Summary of the financial support involved in the financial reorganisation

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Financial support involved in the proposed restructuring

Items Amounts £m

Amounts €m

Notes

HS1 financing

Assumption of GGBs 3,750 4,688 £1,000m 2010; £1,225m 2028; £425m 2038; £1,100m 2051

Assumption of HS1 Debt 2,187 2,734 £748m Section 1 nominal bonds; £571m Section 1 indexed bonds (incl indexation); £600m EIB loans; £250m KfW loans

Stamp duty relief 120 150 NPV 1997. Only required if an asset rather than a share sale. The level will depend on the purchase price of HS1

NR(CTRL) loan purchase […]* […]* Relates to purchase of HS1 and St Pancras operations from Railtrack

Transitional OMR cost shortfall 50 63 OMR payments attributable to domestic operations between restructuring and commercial operations

Less estimated sale proceeds […]* […]* Conservative end of current valuation range; HS1 represents around […]* of this

Total HS1 support [more than 6 bn]*

[…]*

Net HS1 support […]* […]*

EUKL financing

Cancellation of loan for ENS lease termination

110 138 Value of liability in EUKL’s accounts

Prepayment of Ashford International Station lease

[…]* […]* Actual unwind cost (Commission stated that Government guarantee was not notifiable as Aid)

Prepayment of rolling stock leases

183 229 Cost of prepaying existing rolling stock leases

EUKL Recapitalisation […]* […]* Based on maintenance cost differential

Total EUKL support […]* […]*

Total support […]* […]*

Net support 5,169 6,466

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4. INDEPENDENT ADVICE AND MONITORING

135. The UK authorities have undertaken to ensure that the process for financially re-organising LCR complies with the restructuring plan and that the process for selling HS1 is such as to arrive at a fair market price for the exploitation of the asset in question and to deliver value for the UK tax payer.

136. The UK Government has committed to keep the Commission informed of the way that the operation takes effect, consistently with its duty of loyal cooperation with the Commission under Article 10 of the EC Treaty.

4.1. Appointment of independent monitoring advisers

137. The UK Government has entered into contracts, awarded by competitive tender, with two companies to provide independent financial advice on the LCR financial reorganisation and sale project:

- Citigroup Global Markets Limited is contracted to provide financial advice and supervision in relation to the reorganisation of LCR and the disposal of assets including the sale of HS1 Ltd, the owner of the High Speed 1 railway infrastructure business; and

- Deloitte UK is contracted to conduct six monthly audits of the LCR business to report on progress to the UK Government. The UK also has an agreement with Deloitte for it to carry out a post operation audit to provide assurance that the assumption by Government of LCR’s debt and the disbursement of State funds to LCR’s constituent businesses had been carried out as intended.

138. The UK authorities consider that each of these monitoring advisers offers robust, independent advice. However, the UK authorities have also agreed – subject only to any extant contractual obligations with Citigroup or Deloitte – to discuss with the Commission a list of alternative independent financial advisers to assist the Commission in the monitoring of the present decision. The UK authorities would then invite advisers from this list to tender for work that is jointly agreed with the Commission. The UK Government would be liable for the costs of the advisers.

4.2. Functions of the monitoring advisers

139. The UK authorities have committed to discuss and agree with the Commission specific terms of reference in respect of the activities that these monitoring advisers could undertake in relation to the reorganisation of LCR and the sale of HS1 Co.

140. Specifically, these activities will consist in the production of two reports:

- an audit of the financial reorganisation of LCR to demonstrate that the money used had been spent according to the purposes and amounts specified in the State aid notification, and therefore the resultant financial position of the company was as anticipated in that notification; and

- a review of the proposed strategy for the sale of HS1 Co to demonstrate that the sale would be on open and competitive process, designed and

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conducted in such a way as to secure a fair market price and best value for the taxpayer.

141. The UK authorities have also undertaken to discuss and agree with the Commission the letter engaging the companies to carry out those activities of monitoring.

4.3. Reporting obligation

142. The UK authorities have given undertakings that the final reports produced by the advisers, when delivered to the UK Government, will be simultaneously submitted to the Commission by the monitoring advisers.

5. ASSESSMENT OF THE OPERATION

5.1. Presence of State aid

143. Article 87(1) EC Treaty declares any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods and affects trade between Member States incompatible with the common market.

144. State resources: by virtue of the present operation, financial contributions are granted by the UK Government. These contributions are of different nature such as debt assumptions or recapitalisation. They are financed by public resources and imputable to the State. The Commission therefore concludes that the measure implies the use of State resources.

145. Selective economic advantage: The plan contains measures which reduce financial and operational costs that both LCR and EUKL currently bear and confer an advantage that they would not have obtained on the private market. Hence, it provides an advantage to undertakings in the railway sector.

146. The Commission notes that the revised access charging system, which will imply a significant reduction of access charges, has not yet been established. It is therefore not the subject-matter of the present decision. The Commission recalls in this context that where infrastructure use is open to all potential users in a fair and non-discriminatory manner, and access to that infrastructure is charged for at a rate in accordance with Directive 2001/14/EC of the European Parliament and of the Council of 26 February 2001 on the allocation of railway infrastructure capacity and the levying of charges for the use of railway infrastructure and safety certification40 as amended, it normally considers that public financing of the infrastructure does not constitute State aid to railway undertakings41. […]*. Such compliance is nevertheless not the subject of the present decision.

* Read: "The Commission will monitor the compliance of the revised system with Directive 2001/14/EC". 40 OJ L 75, 15.3.2001, p. 29 41 Community guidelines on State aid for railway undertakings (also referred to hereafter as the railway guidelines), OJ C 184, 22.07.2008, p.7, point 25.

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147. Effect on trade between Member States and distortion of competition: When aid granted by a Member State strengthens the position of an undertaking compared with other undertakings competing in intra-Community trade, the latter must be regarded as affected by that aid42. It is sufficient that the recipient of the aid competes with other undertakings on markets open to competition43. In the present case, the notified measure strengthens the position of the beneficiary undertaking in relation to other undertakings active in intra-Community trade.

148. In that regard, the fact that an economic sector has been liberalised at Community level is an element which may serve to determine that the aid has a real or potential effect on competition and on trade between Member States44. At present, there is no EC legislation applicable imposing the opening of the market of passenger transport by rail. However, several Member States including the United Kingdom have already opened their markets in this sector. Moreover, the international passenger rail transport market will be opened to competition at Community level as from 1 January 2010 according to the Third Railway Package45. The notified measures aim at preparing this liberalisation process and their future effects on this opened market need to be taken into account.

149. In addition, it is not necessary that the beneficiary undertaking itself be involved in intra-Community trade. Aid granted by a Member State to an undertaking may help to maintain or increase domestic activity, with the result that undertakings established in other Member States have less chance of penetrating the market of the Member State concerned46. Furthermore, the strengthening of an undertaking which, until then, was not involved in intra-Community trade may place that undertaking in a position which enables it to penetrate the market of another Member State.

150. The Commission concludes that the operation at stake is able to reinforce the competitive position of LCR and EUKL in relation to other undertakings in the intra-community trade and therefore affect trade between Member States and distort competition.

151. As a result of the above, the Commission considers that the notified operation involves State aid to LCR and to EUKL in the meaning of Article 87(1) EC Treaty.

5.2 Compatibility of the measures concerning the financial reorganisation of HS1 infrastructure

152. For assessing the compatibility of the operation, the Commission considers that, as it has already been made in the previous decisions, a distinction should be further made between on the one hand the measures concerning the

42 See, in particular, Case 730/79 Philip Morris v Commission [1980] ECR 2671, paragraph 11; Case C-53/00 Ferring [2001] ECR I-9067, paragraph 21; and Case C-372/97 Italy v Commission, [2004] ECR I-3679, paragraph 44 . 43 Case T-214/95 Het Vlaamse Gewest v Commission [1998] ECR II-717. 44 See Case C-409/00 Spain v Commission [2003] ECR I-1487, paragraph 75. 45 OJ L 315, 3.12.2007, p. 1. 46 See, to that effect, in particular, Case C-310/99 Italy v Commission [2002] ECR I-2289, paragraph 84.

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HS1 infrastructure, which is the major part of the operation (steps 1 to 3 and 5 to 6) and on the other hand the measures specifically relating to the restructuring of EUKL (steps 4 and 7).

5.2.1. Objective of the notified measures

153. The notified measures are deemed to allow the infrastructure part of the project to be established on a stand alone basis, change the nature of the aid already granted but reduce the amount of public support and […]* put in place a sustainable financial structure.

154. The Commission notes that the most significant part of the operation concerns the financial re-organisation of LCR’s activities relating to the HS1 infrastructure. This re-organisation is the final rationalisation of the long-term financial arrangements which were originally put in place in 1998 in order to have HS1 built.

155. As a result, the infrastructure activities will be consolidated in a single entity, i.e. HS1 Co (step 1). LCR debts contracted in the context of the financing of the HS1 project will be assumed by the UK government (step 2). The revision of the access charging system will supplement this set of measures designed to re-organise the financing of the HS1 infrastructure (step 3). At the end of this re-organisation process, HS1 Co will be divested (step 5) and all the proceeds of the sale will be transferred back to the UK government (step 6).

156. The Commission notes that all the measures concerning the HS1 infrastructure will imply a public support of £[…]*47 which is expected to be netted off by sales' proceeds estimated to £[…]*and to be transferred to the UK budget. The Commission notes that this amount is coherent with those of the various debts owed by LCR and already benefitting of an approved State guarantee, either in a direct mode or through the de-risking mechanisms and amounting to £6,256m as of 31 December 200748.The Commission also notes that the existing support approved as State aid and re-evaluated under current assumptions by the UK authorities accounts for £8,631 m (as described in section 2.3.7). A comparison of these figures shows that the total support provided under the proposed measures will be significantly lower than that foreseen by the existing framework previously approved by the Commission, were this to have been fully used (for example all guarantees fully invoked).

157. More specifically, the Commission takes into account the fact that the present operation aim at rationalising the HS1 financing allowing the UK government to escape its remaining long-term guarantees of the debt, especially relating to the de-risking of the project provided by the Access Charge Guarantee and […]* which are both suppressed in the notified measures, related to the HS1 project. In this respect, the operation can ensure

* Read: "definitively" * Read: "more than 6 bn" * Read: "the Domestic Capacity Charge" 47 See detail in section 3.9. 48 See detail in section 2.4.1.

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a more sustainable situation for the operation of the HS1 project now that the infrastructure has been constructed and the long-term viability of the HS1 project, as described in consultant Oliver Wyman study “Traffic and Revenue Forecast for Eurostar and HS1”.

158. In addition, the Commission notes that the operation will enable HS1 Co to be established as a standalone commercial entity. The Commission also takes into account the fact that following the assumption of LCR’s debt by the UK Government, HS1 Co will be able to reset its access charges to a proper market rate allowing for the effective access of new entrants in view of the international passengers rail liberalisation. Finally, the UK government will launch a competition whereby investors can bid for a new concession to manage the HS1 business, and the proceeds of the sale of the concession will revert to the UK government.

159. Finally, the Commission underlines that the UK authorities have committed that, irrespective of the legal basis used for its approval, the operation would be subject to the "one time, last time principle" and that therefore no restructuring aid in the sense of the Rescue and Restructuring Guidelines would be granted to LCR.

5.2.2. Assessment of the compatibility under Article 87 (3) (b): promotion of the execution of an important project of common European interest

160. In its previous decisions relating to the public financing of HS1, the Commission has considered that the exemption provided for in Article 87(3)(b) of the EC Treaty to promote the execution of an important project of common European interest was relevant for the promotion of this project and has accordingly assessed the compatibility of the notified aid measures on that basis. This legal basis was followed by the Commission in the 1999 Decision approving most of the arrangements exposed in the present decision. This approach was also followed in subsequent decisions on the project.

161. In fact, the Commission concluded in its previous decisions that the project satisfied the four criteria for the application of Article 87(3)(b) of the EC Treaty. First, previous financial arrangement measures promoted the execution of the HS1 project. This project was considered to be concrete, specific and well-defined. This project was obviously important both quantitatively and qualitatively. The project was of common European interest, as a cornerstone of the high speed rail link between the UK, France and Belgium. Moreover, HS1 was one of the 14 priority projects identified at the Essen European Council. On this basis, the Commission approved the financial arrangements necessary for the execution of the HS1 project.

162. The Commission considers that there are no elements preventing the Commission to reaching the same conclusion as in its previous decisions that this final financial re-organisation of HS1 is compatible with the common market as it promotes the execution of an important project of common European interest in the context of the present decision.

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163. This is the case even though the construction of the HS1 infrastructure is now complete. The Commission notes indeed that the financing of the project has always been contemplated as a long term exercise which would last well beyond the completion of the construction. The Commission also underlines that in order to conclude that a measure promotes the execution of an important project of common European interest, such a measure must indeed include its investment phase. However the Commission also considers that the execution of a project goes beyond this investment phase but may also include the implementation of that project. For projects of this importance, it is in fact not possible to distinguish the financing aspects from the physical construction or operations of the infrastructure. These aspects are intrinsically related: the HS1 project has been originally conceived and budgeted so as to take the construction and the operation into account, to do otherwise by artificially scinding the financing aspects from the other aspects would be illogical. As a result, the Commission considers that the necessity and the incentive effect of the aid has to be assessed with regard to the whole execution of the project, including the financial arrangements allowing for its long-term viability and for the availability of the project for users in the European common interest.

164. In this regard, the Commission notes that its previous decisions adopted since 1999 mainly focused on the financial arrangements for the execution of HS1 project. These arrangements were approved to ensure the financial viability of the project on the long term. The 2003 Commission decision was even adopted almost simultaneously with the completion of the construction of section 1 of HS1 although it partly concerned financial arrangements on this specific section.

165. In addition, the Commission considers that the following elements should also be taken into account for assessing the compatibility of the measures regarding the HS1 infrastructure.

166. Firstly, LCR's businesses will be separated in order to achieve appropriate commercial incentives and risk transfer. LCR will be divested of the HS1 asset following a public sale process. The Commission takes note of the commitments undertaken by the UK authorities to ensure an independent monitoring of the sale of HS1 in order to maximise the value for the tax payer and appropriately inform the Commission.

167. Secondly, all the sale proceeds and other cash proceeds of LCR’s businesses will be remitted to the UK Government. The sale of LCR’s property interests will be carried out by competitive process and will involve no distortion of competition.

168. Thirdly, the concession period for HS1 which currently extends to 2086 will be significantly shortened to around 35 to 40 years from the completion of the sale of HS1. This will effectively ensure a second competition during the lifetime of the original concession.

169. Fourthly, LCR’s shareholders will not receive a return from the sale of LCR’s HS1 asset and LCR will subsequently be wound up.

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170. In conclusion, the Commission considers that the operation involves various positive elements in terms of competition, as described above.

171. As a result, the Commission considers that the financial re-organisation of HS1 infrastructure is necessary to promote the execution of the HS1 project by ensuring its long term sustainability and is therefore compatible with Article 87 (3) (b) EC.

5.2.3. Conclusion

172. In view of all the considerations expressed in Sections 5.1.1 to 5.1.3 above, the Commission is of the opinion that the aid measures concerning the financial reorganisation of HS1 infrastructure and amounting to […]* are compatible with the common market under Article 87(3)(b) EC Treaty.

5.3 Compatibility of EUKL restructuring measures

173. The Commission notes that the second part of the operation concerns the restructuring of EUKL (steps 4 and 7). This restructuring will lead to the rationalisation of EUKL balance sheet via in particular the cancellation of certain debts and pre-payment of leases (see point 105). It will also consist in a recapitalisation and fleet replacement.

174. The Commission notes that the public support involved in EUKL restructuring amounts to £[…]*49.

175. Article 87(3)(c) provides that State aid can be authorised where it is granted to promote the development of certain economic sectors and where this aid does not adversely affect trading conditions to an extent contrary to the common interest.

176. As regards specifically EUKL restructuring, the applicable Community framework for deciding on compatibility is the Community guidelines on State aid for rescuing and restructuring firms in difficulty50 (hereafter the "R & R guidelines"), applicable to railway undertakings according to the guidelines on State Aid for railway undertakings.

177. The Commission has therefore to assess whether EUKL restructuring complies with the provisions of the applicable guidelines the basic principle (point 31 of the R& R guidelines) of which is to ‘allow the grant of restructuring aid only in circumstances in which it can be demonstrated that it does not run counter to the Community interest. This will only be possible if strict criteria are met, and if it is certain that any distortions of competition will be offset by the benefits flowing from the firm's survival…and that, in principle, there are adequate compensatory measures in favour of competitors.’

178. The guidelines then set out a number of conditions under which restructuring aid can be granted.

* Read: "more than £6bn" 49 See detail in section 3.9. 50 OJ C 244, 1.10.2004, p. 2

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5.3.1 Eligibility of the firm

179. First, the Commission must determine if EUKL is eligible for restructuring under the terms of the R & R guidelines. Point 9 of the guidelines states that there is not a Community definition of a company in difficulty, and adds that "the Commission regards a firm as being in difficulty when it is unable, whether through its own resources or with the funds it is able to obtain from its owners/shareholders or creditors, to stem losses which without outside intervention by the public authorities, will almost certainly condemn it to going out of business in the short or medium term".

180. Subsequently the guidelines (point 10) clarify that "a firm is, in principle and irrespective of its size, regarded as being in difficulty for the purposes of these Guidelines in the following circumstances (a) in the case of a limited liability company where more than half of its registered capital has disappeared and more than one quarter of that capital has been lost over the preceding 12 months".

181. EUKL balance sheet showed total net liabilities and deficit in shareholder's equity of £1,730.6m in 2007 and £1,861m in 2008. EUKL has registered share capital of £701 million, and had an operating loss deficit of £2,578million at 31 December 2008. On this basis, there has certainly been loss of more than 50% of registered capital, indeed 100% has been lost many years ago and the deficit continues to rise. EUKL's trading losses (i.e. capital movements) in the 12 months to 31 March 2009 were some £[…]*, which amounts to a further […]*% of the original registered capital in the last 12 months. This loss comprises EUKL's first quarter's losses of 2009, 3/4 of its 2008 losses, and EUKL's estimated share of the pension deficit arising in 2008.

182. In point 11 it is also stated that "Even when none of the circumstances set out in Point 10 are present a firm may still be considered to be in difficulty in particular where the usual signs of a firm in difficulty are present, such as increasing losses, diminishing turnover, growing stock inventories, excess capacity, declining cash flow, mounting debt, rising interest charges and falling or nil net asset value".

183. LCR provides funding for its subsidiaries. EUKL’s operating losses amount to up to £[…]* per annum. With the existing level of HS1 access charges EUKL is not a financially viable entity without State subsidy. EUKL would probably not be able to stem its losses and continue trading, absent continuing support from the UK government.

184. To the extent that LCR funds EUKL’s trading deficits via the inter-company loan, EUKL is also a “firm in difficulty” within the meaning of the R&R Guidelines.

185. In view of LCR financial situation as described in section 2.4.1., it is clear that the difficulties of EUKL are too serious to be dealt by the group. Indeed, the present operation consisting in financially reorganising LCR implies significant public support and makes it clear that LCR could not ensure the restructuring of its subsidiary. In addition, the difficulties of EUKL do not result from cost allocations within the group, taking into consideration that

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the current access charges were determined in access agreements in the context of the 1998 restructuring. As a result, the Commission notes that EUKL fulfils the condition set out in point 13 of the R&R guidelines.

186. As a consequence, EUKL must be regarded as a firm in difficulty in the sense of the R& R guidelines.

5.3.2. Restoration of the firm’s long-term viability

187. The second condition (as set out in point 35 of the R & R guidelines) to be complied with is that the “restructuring plan, the duration of which must be as short as possible, must restore the long-term viability of the firm within a reasonable timescale and on the basis of realistic assumptions as to future operating conditions".

188. The Commission must also evaluate if the assumptions on which the restructuring has been based are reasonable in the circumstances and if the predictions and forecasts correspond with what is required in the guidelines. The R & R guidelines provide (point 35) that "the plan must be submitted in all relevant detail to the Commission and include, in particular, a market survey. The improvement in viability must derive mainly from internal measures contained in the restructuring plan; it may be based on external factors such as variations in prices and demand over which the company has no great influence, but only if the market assumptions made are generally acknowledged".

189. The same guidelines (point 37) go on to provide that "the plan must provide for a turnaround that will enable the company, after completing its restructuring, to cover all its costs including depreciation and financial charges. The expected return on capital must be enough to enable the restructured firm to compete in the market place on its own merits".

190. The Commission notes that the UK authorities have notified the restructuring plan of EUKL containing a detailed description of the range of restructuring measures. The restructuring plan was accompanied and based on the result of a study (including a market review) from the consultant Oliver Wyman (“Traffic and Revenue Forecast for Eurostar and HS1”) and a consultation process of the revised access charging system. The UK authorities have also specified that the restructuring plan received the approval of the Board of the UK Department for Transport to proceed with the application and associated restructuring.

191. The Commission have analysed the assumptions, methodology and findings of the study presented in the notification and described in section 3.5. The Commission analysis does not lead […]* to put the consultant conclusions into question. In particular, the Commission considers that the assumptions made by the consultant for modelling the different scenarios according to economic variation are reasonable.

192. The Commission considers that the restructuring of EUKL is also designed to ensure that EUKL becomes viable on the long-term. The viability should be reached by ensuring that EUKL is both sustainable in a range of market

* Read: "it".

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conditions and has a credible strategy for fleet replacement in the longer term in view of the opening of the market to competition.

193. In this regard, the Commission agrees with the conclusions of the consultant hired by the UK authorities. Indeed, the consultant market tested the restructuring measures by developing a number of plausible competitive scenarios to assess whether EUKL, after the planned changes together with the proposed balance sheet restructuring and recapitalisation, would be capable of reaching a financially sustainable position. The analysis includes traffic and revenue forecast up to 2022.

194. This market analysis modelled three competitive scenarios (“EUKL High Case”, “Downside Case”, “Central Case”) in detail in order to forecast, given the impending market liberalisation, the future prospects for supply and demand in the cross channel rail passenger services market and the likelihood of competitors entering that market. The forecasts show that in the Central and High Cases EUKL passes the test of sustainability. In the Downside Case, the Commission observes that EUKL EBITDA would approximate £[…]* in 2012, which can be considered as acceptable.

195. The Commission has examined the analysis and the supporting assumptions of the consultant. The Commission does not raise any objection to the quality of this analysis and notes that the results do not lead to excessive profitability of EUKL. Indeed, the fact that according to the downside scenario EUKL would not make profit but still would remain more or less break-even over the years (as shown in section 3.5.3, points 122 and 123) leads the Commission to consider that the restructuring measures are reasonably sized and will enable to ensure EUKL long term viability. In addition, forecasts and calculations of EUKL profitability according to the different scenarios are in line with the profitability of other European transport operators.

196. Furthermore, the Commission takes note that the UK government intends to implement the restructuring plan in full shortly after the adoption of the present decision […]*.

197. In the light of the above-mentioned factors, the Commission considers that the restructuring plan will be able to ensure EUKL financial viability within a reasonable time, as foreseen by EUKL restructuring plan.

5.3.3. Avoidance of undue distortions of competition: compensatory measures

198. The R & R guidelines provide (point 38 thereof) that "in order to ensure that the adverse effects on trading conditions are minimized as much as possible, so that the positive effects pursued outweigh the adverse ones, compensatory measures must be taken. Otherwise, the aid will be regarded as "contrary to the common interest" and therefore incompatible with the common market".

199. It is further specified (point 39) that "these measures may comprise divestment of assets, reductions in capacity or market presence and reduction of entry barriers on the markets concerned. When assessing whether the compensatory measures are appropriate the Commission will take account of the market structure and the conditions of competition to ensure that any such measure does not lead to deterioration in the structure of the market".

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200. Finally (point 46), specific conditions may be attached to the authorisation of the aid in addition to the compensatory measures.

201. The Commission must therefore examine the restructuring and determine if sufficient measures have been taken in relation to EUKL so as to minimise the distortive effect of the aid.

202. In this context, the Commission notes that the restructured package of support is designed to facilitate liberalisation of the market for international passenger rail services, especially through the adoption of a revised access charging system characterised by a significant reduction of the charges level. Keeping access charges at their current level for the sole necessity of supporting LCR's revenues and financial position could impede new entrants to enter the market and maintain EUKL in a quasi monopolistic situation. In consolidated terms the current situation has no effect on LCR/EUKL as the company both invoices and pays the access charge. Thereby, the restructuring measures and especially the reduction of access charges will lead to increasing the scope for competition on this market and will therefore affect EUKL current position in the market. In this regard, it should be recalled that EUKL will be facing competition as from 1 January 2010 following the liberalisation of international passenger transport by rail.

203. In addition, the Commission is of the opinion that the following elements of the restructuring plan can be considered as compensatory measures or specific conditions to the restructuring aid.

204. The restructuring plan will require for EUKL to surrender the considerable protections provided by the extensive public support approved in the Commission’s 1999 Decision, notably the Access Charge Guarantee and the Access Charge Loan Facility.

205. Parallel to EUKL restructuring, the train operation activities will be separated from LCR infrastructure activities, which will impact EUKL operations in particular in relation to its access to the infrastructure, the stations or the maintenance services as described in points 77-81. This will result in an improved implementation of the principles governing the rail transport market according to the Community legislation. This will lead to a better functioning of the market in the context of the forthcoming liberalisation of international passenger transport by rail.

206. Furthermore, the investment recovery element of the access charge will be reset at a reduced level which will lower barriers to entry in the market for the operation of cross-channel passenger rail services. Such measure should foster competition as new entrants will be able to afford access to the railway.

207. The Commission notes that reinforced monitoring obligations are introduced as described in section 4 of the present decision.

208. Having regard to the particularities of the HS1 project which involved significant public support and the forthcoming opening of the international rail passenger transport market and on the basis that EUKL will now operate on a more sustainable and less distortive basis, the Commission can conclude

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that sufficient compensatory measures and specific conditions do address the market distortions that will be occasioned by the restructuring.

5.3.4. Aid limited to the minimum

209. The R & R guidelines (point 43) provide that the "amount and intensity of the aid must be limited to the strict minimum of the restructuring costs necessary to enable restructuring to be undertaken in the light of the existing financial resources of the company, its shareholders or the business group to which it belongs. Such assessment will take account of any rescue aid granted beforehand".

210. The Commission considers that this condition is fulfilled in the present restructuring.

211. The Commission recognises that the restructuring plan presents clear grounds and justifications for the novation of the Ashford International Station lease to HS1 Limited and the cancellation of the UK government loan to EUKL to terminate ENS rolling stock leases. It appears also clear to the Commission that EUKL would have no prospects for long-term (or even medium-term) viability if it was not divested of these legacy costs.

212. In relation to the proposed pre-payment of the rolling stock leases and the recapitalisation to offset the difference in operating costs between EUKL and its competitors, the Commission notes that, on the basis of the analysis provided by the UK authorities and supported by the consultant conclusions, this support is both necessary and proportionate.

213. Indeed, the Commission underlines that the analysis has modelled the proposed restructuring support against different scenarios and proposes comparison of performance with other operators in the European transport sector. The Commission has examined this analysis which identified the expected profitability of EUKL. The forecast EBITDA of EUKL would be […]*% (high case) and […]*% (central case). The Commission notes that these figures are in the same range or even lower than other European transport operators (such as 14% for Deutsche Bahn or 5,5% for National Express).

214. The guidelines (point. 43) provide that aid beneficiaries are expected to make a significant contribution to the restructuring plan from their own resources. This own contribution consists in the part of restructuring costs which is not covered by the aid granted in the context of the restructuring.

215. As regards EUKL restructuring, the following measures are considered as aid to EUKL: the prepayment of rolling stock leases, the cancellation of loan for ENS lease termination, the prepayment of Ashford International Station lease and the EUKL recapitalisation as described in section 3.5, for a total amount of £[…]*.

216. However, the Commission notes that EUKL renounces in return to a certain number of rights, which can be considered as an own contribution.

217. First, EUKL will no more be covered by the Access Charge Guarantee which is a State guarantee on the access charges paid by EUKL to access HS1, as described in section 2.3 and previous Commission decisions. The Access

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Charge Guarantee will be removed by the UK Government in the context of the present operation.

218. Second, EUKL will renounce to the Access Charge Loan Facility which constitutes public support to EUKL for maintaining the project's liquidity and can be drawn to fund EUKL's payment of access charges. The Access Charge Loan Facility would not be drawn until after 2010. This facility is estimated to £550m. In the context of the present operation, this facility is also removed in return of the debt cancellations and restructuring measures.

219. Third, the lease of Ashford International Station, currently held by EUKL will be novated to HS1 Co as part of the transfer of all infrastructure activities in a single entity. This means that EUKL will then have to contract for access to Ashford International Station on an open access basis

220. The Commission observes that the valuation of these elements is rather difficult: on the one hand they include capital contributions, loan cancellations and prepayment of leases as far as aid measures are concerned; conversely the own contribution of EUKL to its restructuring includes the renouncement of advantages previously enjoyed under the form of guarantees and leases or potential future advantages such as the £550m loan facility. On balance, under the very specific considerations of the case and especially taking into account this loan facility, the Commission considers that the minimum level of own contribution of 50 % indicated in the R&R guidelines can be considered as satisfied in the present case.

221. As a consequence, the Commission concludes that the aid included in EUKL restructuring is limited to the minimum.

5.3.5. “One time last time” principle

222. The Commission notes that one of the main objectives of the restructuring for the UK government consists in reducing its financial exposure and in ending its long-term support commitments to the project.

223. In addition, the Commission recalls that the restructuring plan will lead to the separation of LCR’s businesses and LCR itself will be wound up. The property element will be sold and the use of the infrastructure will be let as a new but shorter concession.

224. Furthermore, the UK authorities acknowledged that EUKL will be sufficiently capitalised to face a competitive market and that it will not propose to step in with additional operational funding in the future.

225. In relation to the one time, last time principle the guidelines (point. 73) provide that " When planned rescue or restructuring aid is notified to the Commission, the Member State must specify whether the firm concerned has already received rescue or restructuring aid in the past, including any such aid granted before the date of application of these Guidelines and any unnotified aid. If so, and where less than 10 years have elapsed since the rescue aid was granted or the restructuring period came to an end or implementation of the restructuring plan has been halted (whichever is the latest), the Commission will not allow further rescue or restructuring aid".

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226. The Commission notes that the guidelines (point 19) also provide that " (…) the only basis on which aid for firms in difficulty can be deemed compatible is Article 87 (3) (c)". It should be mentioned that previous aid granted to EUKL was based on Articles 87(3)(b) and 73 EC Treaty and that EUKL did not receive rescue or restructuring aid in the past

227. The present restructuring aid package is therefore in line with the "one time, last time" principle as described in Section 3.3 of the R&R guidelines.

5.3.6. Conclusion

228. On this basis, the Commission concludes that EUKL restructuring plan complies with the provisions of the R&R guidelines.

229. The aid measures notified in favour of EUKL and amounting to £[…]* are therefore compatible with the common market under Article 87(3)(c) EC Treaty.

6. DECISION

The Commission has accordingly decided not to raise objection to the notified measures on the ground that they are compatible with the common market under Art 87(3)(b) and (c) of the EC Treaty.

If this letter contains confidential information which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of the letter in the authentic language on the Internet site: http://ec.europa.eu/community_law/state_aids/index.htm Your request should be sent by registered letter or fax to:

European Commission Directorate-General for Energy and Transport Directorate A, Unit A.2 B-1049 Brussels Fax No: + 32.2.296.41.04

Yours faithfully, For the Commission

Antonio TAJANI

Vice-President of the Commission