Hong Kong has a world-class mass transit system and using the railway as the backbone of the public transport system is a stated government policy. With over 39.6% of daily commuters using the railway, rail fares have become a sensitive issue.

Prior to 2007, Hong Kong had two railway operators, the Mass Transit Railway Corporation and the Kowloon-Canton Railway Corporation. The two corporations were merged in 2007 and the adoption of a more objective and transparent Fare Adjustment Mechanism (FAM) was one of the several parameters set by the Government of Hong Kong for the rail merger negotiation back in 2004. For public transport regulators around the world, it is of interest to understand the basis for an objective fare adjustment mechanism and why, despite the ‘objectivity’, there continues to be issues of concern and criticisms.

Background

• Before the rail merger, railway services in Hong Kong were provided by two railway corporations, the Mass Transit Railway (MTR) and the Kowloon-Canton Railway (KCR). MTR was established in 1975 with the Government as sole shareholder to construct and operate an urban metro system to help meet Hong Kong's public transport requirements. It was listed in October 2000, as the MTR Corporation Limited (MTRCL), with the Government currently owning about 77% of MTR shares. The KCR came into service in 1910 providing rail service from Tsim Sha Tsui in Kowloon through the New Territories. KCR was corporatised in 1982, as KCR Corporation (KCRC). 

• The Government of Hong Kong invited the two railway companies to commence discussions on a possible merger in early 2004, and had set, among a number of key parameters for the merger discussions, the adoption of a more objective and transparent FAM.

• The Legislative Council (LegCo) subsequently passed in June 2007 the Rail Merger Ordinance which provided the legal framework for MTRCL to operate both MTR system and KCR system. The rail merger later took effect from 2 December 2007.

The FAM

• Before the rail merger, railway companies enjoyed fare autonomy, and they set fares in accordance with prudent commercial principles with regard to; inter alia, economic conditions, competition from other transport modes and whether the services were value for money. Unlike franchised bus fares, there was no need for approval by the Executive Council (ExCo) of the new rail fares.

• In the context of the rail merger exercise, the railway companies agreed to adopt a formulaic approach, namely the FAM, for determining future fare adjustments to replace fare autonomy. If there were economic downturns and deflation, FAM would require a fare reduction too.

• Though the railway companies considered that the FAM would be inferior to fare autonomy, it was recognised then that the FAM would help depoliticise rail fare adjustment in the future, such that there would be no need for any debate while the fare adjustment would be automatic and easy to understand by the public.

• Upon the rail merger, FAM was introduced and this would be subject to a review every five years upon request either by the Government or MTRCL. If no agreement is reached on modification, the FAM will continue to apply.

• The FAM adopted a “direct drive” fare adjustment formula as follows: Overall Fare Adjustment Rate = 0.5 x Change in Composite Consumer Price Index + 0.5 x Change in Wage Index - Productivity Factor.

• Under the FAM, rail fares would be reviewed once per calendar year with the overall fare adjustment rate calculated by a set formula based on the Census and Statistics Department, publishing year-on-year percentage changes in the Composite Consumer Price Index (“CCPI”) and Nominal Wage Index (Transport Services) for December of the preceding year as well as a pre-determined productivity factor. The productivity factor was 0% before 2013 and 0.1% as from 2013. If the overall fare adjustment rate calculated fell within the range of ±1.5%, there would be no fare adjustment and the rate would be rolled over to the next annual fare review.

Criticisms about FAM

• The FAM was implemented for the first time in 2009 and so far there have been rail fare increases annually since 2010. Both the public and the politicians have criticised the fare increases saying they were not appropriate given that the railway company had accumulated huge profits over the years. 

• Some pointed out that MTRCL was a public company and enjoyed certain degree of monopoly due to the government policy of making the railway the backbone of the public transport system; hence MTRCL should take care of the interest of the public and should not only operate for the interests of its shareholders. 

• Some regarded that MTRCL was attaching greater importance to profit-making than to its corporate social responsibility. There were concerns that the rail fare increases would add to the pressure of living costs and would cause public resentment, now that more and more people had to rely on rail services than other road-based transport modes that diminished with the expansion of the rail networks.

• Criticisms also pointed to that fact that the Government, being the major shareholder of MTRCL, should have the responsibility to protect public's interest. The Government should not be seen as not doing anything to prevent the fare rise which only benefits the interest of minority shareholders of the railway company. This would unnecessarily create a direct conflict between the travelling public and the investors. 

• The fare increase of 5.4% in 2012, in particular, far exceeded the affordability of the general public as the wage increase of many sectors were below that rate and could not catch up with the fare increase rate.

• The FAM was stated in the Operating Agreement which binds both the Government and the company. There were views that the FAM in effect was even less flexible than the fare autonomy before the rail merger, as the statutory status of FAM had given less room for both the Government and MTRCL to manoeuvre. 

• The FAM had the merits of being automatic, direct drive and transparent, but the down side of it was the removal of any discretionary power of the Government and the railway company not to follow the FAM result.

Suggestions for Improving FAM

• Members of the public generally acknowledged that the replacement of fare autonomy by a FAM was an improvement. On the other hand, they considered that MTRCL should use part of its profits derived from property development to set up a fare stabilisation fund or a profit-sharing scheme to help moderate the fare increase on there should a cap on the rate of fare increase. Some asked for the inclusion of new factors, such as public affordability and acceptability into the FAM formula. The stance of the Government and the railway company on the above suggestions had been that railway development was highly capital intensive, not only during the initial construction phase but also throughout the life of the operation. To ensure long-term sustainability for provision of safe and quality passenger service and also to meet the demand of a listed company, a railway company would need to earn a reasonable commercial return.

• The railway company also considered it inappropriate to impose an artificial cap on the overall fare adjustment rate, which would be inconsistent with the regulatory approach of adopting a direct-drive fare adjustment formula.

• There were also suggestions for the Government to use the dividends (regarded as a form of indirect tax imposed on the public) it received as a shareholder of MTRCL, to set up a fare stabilisation fund to moderate the rate of fare increase. The Government, however, maintained the stance that the proposal was not in line with the general framework of public finance management.

• Some LegCo members suggested that a demerit point system or a performance-linked component be introduced under the FAM whereby rail fare adjustments would be linked to the standard of service with a view to motivating the railway company to improve its services and reducing the frequency of rail incidents. 

• The Government in response stated that the suggestion, if pursued, should not unnecessarily incur additional pressure on frontline railway staff, so that it would not bring about any adverse impact on railway safety checks and emergency repairs in their tight timeframes.

The Review

• In response to the criticisms and suggestions for improving the FAM, the Government requested MTRCL to jointly conduct a review on the FAM in August 2012, the fifth year after rail merger. According to Government, the objective of the review was to "incorporate service performance and profitability of MTRCL, as well as public affordability as additional factors for consideration in the FAM."    

• With the above-said review objective in mind, the Government had reached with MTRCL a package of proposals, and the ExCo approved in April 2013 the outcome of the review for implementation as from the fare adjustment for 2013. The key features of the package were as follows:

1. The existing direct drive formula would be retained but improved. This would result in the productivity factor value being improved from 0.1% (value in the original FAM formula) to 0.6%, so that the 2013 fare adjustment rate would be immediately brought down from 3.2% to 2.7%

2. The railway monthly passes scheme offered to passengers would be comprehensively enhanced with a view to benefitting those more frequent, medium and long journey rail passengers

3. A public affordability cap would be introduced which would be based on the change in the Median Monthly Household Income (MMHI), such that any fare increase would not be higher than the corresponding figure for that year. Any shortfall would be recouped in two phases in years when the calculated fare increase rate was lower than the rise in MMHI

4. A profit sharing mechanism, based on the MTRCL’s underlying business profits each year, including profits from property developments and overseas ventures, would apportion a pre-determined amount of share (about 1.5% of overall business profits) to an account to support time-limited fare concessions i.e., the "10% Same Day Second Trip Discount"

5. There would be a service performance arrangement where service disruptions lasting 31 minutes or more, except for those outside the MTRCL’s control, would result in the MTRCL being fined (ranging from HK$1 million to HK$15 million), and the amount put into the fare concessions account to finance the "10% Same Day Second Trip Discount" scheme

What next?

• As expected, the politicians and the general public continued to criticise that the outcome of the review had fallen far short of their expectations. Major feedbacks to the outcome of the review included:

1. The difference of only 0.5% in the fare increase for 2013 (reducing from 3.2% to 2.7%) under the new FAM represented not so much a good deal to relieve passengers' financial burden 
2. In terms of fare concessions for 2013, the new FAM offered passengers far less than what MTRCL offered in 2012  
3. The proposed profit sharing mechanism was grossly inadequate which represented only a negligible amount (i.e. 1.5%) for a railway company of huge annual profits it obtained from property development
4. The cap on fare hikes allowed the shortfall to be accumulated and recovered in the following years, which was designed less in regard to public affordability than in regard to MTRCL's interest
5. The fare concessions offered for same-day return trips only, and the penalty for service disruptions would be more a gesture than substantial fare reduction for the benefit of the travelling public.

• While the community might not be entirely happy with the new FAM, it has to be admitted that the agreed package of proposals was an attempt of the Government to rationalise MTRCL's fare increases further.

• While noting that the new fare mechanism was still based on the three factors, namely the year-on-year change in the CCPI, the change in wage index and the productivity factor, the impact of the greatly enhanced productivity factor meant an immediate cutback of the fare increase for 2013. The revised proposals covered three new key components not forming part of the formula, namely the public affordability cap, the profit sharing mechanism and the service performance arrangement (or service disruption-linked penalty). Although the deal reached under the new arrangement might not be seen by commuters as having gone far enough, it has demonstrated that an objective fare adjustment mechanism actually allows rooms for adjustment based on rationale discussions and should be the right way forward.

References:

Legislative Council Brief on "Review of the Fare Adjustment Mechanism of the MTR Corporation Limited" (April 2013) http://www.legco.gov.hk/yr12-13/english/panels/tp/papers/tp0419-thbtcr33101799-e.pdf

Government's Reply to Legislative Council Question by the Hon Michael Tien (18 June 2014) (LCQ9: MTR profits and fare concessions) http://www.info.gov.hk/gia/general/201406/18/P201406180408.htm]